Posted on Tuesday, August 20, 2013
Many of our buyers and sellers ask us why mortgage rates are rising. They hear about actions by the Federal Reserve or the end of “quantitative easing” and it all seems so distant and sometimes confusing but they want to know how it all works – in simple terms. So here goes …
First we need to say we cannot predict interest rates and in no way do our thoughts help you predict rates nor should you use this information to make financial decisions. Consult with your financial planner or a financial planner for any investment decisions you need to make.
For those looking for the shortest explanation as to why mortgage rates are rising here it is … The federal reserve is considering curtailing its bond buying program since in theory the economy is now improving and needs less stimulus (setting all political commentary aside). If bond buying slows then there is less bond demand and rates rise to attract more buyers. Market interest rates including mortgage rates rise as a result – and your mortgage rate ends up higher than the 30 year treasury rate because you are more “risky” than the US Government.
For those needing a little more explanation – and perhaps loving detail – let’s continue on.
Many factors influence interest rates but one of the most powerful forces is supply and demand. Supply and demand forces move interest rates, including mortgage rates, just as supply and demand moves house prices. If more people want to buy a house when few houses are available then people compete to buy the house and the price of the house rises. If there are more houses for sale than buyers then the price of the house will fall to make the house more attractive to the buyers.
But how does supply and demand impact interest rates? Well let’s look at the 30 year treasury. This is an obligation of the United States Government that will pay its owner interest for the next 30 years and then allow the owner to sell the bond at any future point.
Ok so what? Well the interest rate on the bond is the so what. If a lot of people want to buy these bonds (demand) then the bonds are easier to sell and you do not have to offer a high interest rate to sell them – heck if a lot of people want them then you may offer lower rates to sell them – why give away the store when you do not have to.
So in periods of high demand interest rates are low on these bonds.
But … what demand falls? Well when demand falls you need to make the bonds more attractive to fewer buyers. How do you do this? You offer a higher interest rate to make them more attractive. In actual practice the market in every day trade between bond buyers and sellers establishes the 30 year treasury rate – not one person. The market rate may be found on many online sites. For example see CNN money and click on the 10 year yield on the top right corner of the page (http://money.cnn.com/data/bonds/).
So in periods of high bond demand interest rates on treasuries are low, in times of low bond demand interest rates on treasuries are high. Supply and demand.
Ok so who buys these bonds? Well of late, the Unites States Government buys these bonds as well as foreign investors and governments. Why would the United States Government buy its own bonds? Well leaving politics aside, when the government buys the bonds (demand goes up), interest rates fall and the economy (in theory) may recover more easily. Why? Because with low interest rates money is “cheaper” and may be borrowed to do all sort of things like funding new projects and businesses which in theory gets things going again.
But what if the government decides to stop buying its own bonds? Well you know by now what happens – demand decreases and interest rates rise. Why? Well with fewer buyers the bonds need to trade in the market at a higher rate to make the bond more attractive to buyers .
So how does this impact my mortgage rate? The government may discontinue buying its own bonds. If this happens demand will fall and rates will rise. In fact the mere thought of this happening will cause the market in day to day trade to raise rates on the bonds to make them more attractive.
But what has the 30 year treasury have to do with my mortgage? Well quite simply if the thirty year treasury bond needs to offer 4% interest to attract enough buyers and is backed by the US government then what interest rate will you need to offer the market to lend you money for your house for 30 years? Well, a higher interest rate. Why? Because you (in the eyes of the market) are more risky than the US government. Treasuries rise, your mortgage rate rises.
So … The federal reserve is considering curtailing its bond buying program since in theory the economy is now improving and needs less stimulus the economy (again politics aside). If this happens then bond demand falls and rates rise to increase attractiveness. Your mortgage rate also rises and your 30 year mortgage rate rate is higher than 30 year treasury rate because you are more “risky” than the US Government.
This is the most simple way to understand rising mortgage rates. Again, you cannot predict them. We hope this helps you understand the basics. We intentionally set politics aside. We also set aside commentary on bond prices (as opposed to rates) as prices move inversely to rates – a fact not necessary to delve into to explain the supply and demand impact above.
So … talk to your mortgage broker, banker or financial professional for advice on these matters. We are not financial advisors and do not predict rates nor should rely on this commentary to make financial decisions. We simply offer this commentary to help show how supply and demand – for the most part – drives mortgage rates.
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Mark Goebel, PA is a REALTOR with Coldwell Banker on 5th avenue in Naples, Florida with 35+ years of visiting and living in Naples. After 25 years at Accenture, Mark retired as a managing director and spends his time helping non profits and building a Naples real estate team with his wife Nan. Talk to Mark and Nan about life in Naples and why they chose this place to live full-time over all others and enjoy Naples real estate.
Mark Goebel, PA REALTOR Coldwell Banker 5th Avenue South Mobile: 239.595.3921 NaplesBestAddresses.com Facebook: NaplesBestAddresses Youtube http://www.youtube.com/user/naplesbestaddresses?feature=results_main