The rate on 30-year mortgages rose for a third straight week, hitting the highest level in more than three months. The 30-year, fixed-rate mortgages averaged 6.24 percent this week, up from 6.04 percent last week. Rates on 15-year mortgages rose to 5.72 percent from 5.64 percent. Rates on five-year adjustable-rate mortgages rose to 5.43 percent from 5.37 percent. Rates on one-year ARMs climbed to 5.11 percent from 4.98 percent.
Many people are asking why mortgage rates have gone up recently when the Fed dropped the Prime Rate. It’s a very common misunderstanding about how exactly 30 year mortgage rates come about. Firstly, 30 year mortgage rates do not parallel the Prime Rate (the rate at which banks lend money to their best prime customers). Rather, these mortgages follow Treasury Bonds, specifically the ten year bond rate. We’ll get to that in a minute. The Prime Rate will affect adjustable rate mortgages, credit cards, and lines of credit based specifically on this number. Personally I have a line of credit in which I pay prime plus 1/4 point. So when the Fed dropped the prime rate recently, it was all good news. Your adjustable rate mortgage just got easier to pay as well. Additionally, many credit cards companies follow the Prime Rate patterns when adjusting their rates.
There are a few downsides to dropping the Prime Rate however. If you have CD’s and high yield savings accounts, those interest rates will drop as well.
So, why does the Fed drop the Prime Rate you ask? The idea here is to fend off a recession. Everybody is worried about the state of the U.S. economy. Lower rates mean cheaper loans. People can borrow money. Whether it’s businesses or individuals, everyone is going to find it easier to do business and the economy is more likely to expand.
So how does the 30 year mortgage actually work with Bonds? Well the US Government is really a great person to lend money to. It has never defaulted on a loan and is considered very safe, thus the lower yield for the bond you buy. These bonds are generally given in 30 year maturity dates. Hence the correlation to the 30 year mortgage. The direct impact on you, the home-buyer, is that higher Treasury note and bond yields mean that the Treasury Department will be forced to pay a higher interest rate to attract buyers. Over time, these higher rates can start to increase demand for Treasury notes and bonds, thereby increasing the value of the dollar, staving off inflation. High demand for Treasury notes and bonds means low yields, which means low interest rates. This makes housing more affordable, which stimulates the housing market and the economy. Conversely, higher note and bond yields mean higher mortgage interest rates, which means you have to buy a smaller, less expensive home. This slows down the economy.
So it’s the delicate balance of managing inflation, the nation’s debt and priming the economy that makes these rates go up and down.
