What Moves Mortgage Interest Rates? The DEVIL!

When I asked my 5 year old daughter where babies come from she said they were flown down from heaven on the wings of pink unicorns. When I asked a client where mortgage interest rates come from I got the same answer.

If you want to know the external forces that move mortgage interest rates don’t look up, look down! The DEVIL is the culprit. DEVIL is an acronym for Demand & Supply, Economic Outlook, Volume, Intermediate Term Bonds, and Lasting Inflation.

Demand and Supply is the keystone of capitalism and it has a profound effect on the movement of mortgage interest rates. Mortgages are packaged and sold as investment instruments called Mortgage Backed Securities (MBS). These investment vehicles are considered safer than stocks but riskier than treasuries. Therefore they have a varying demand based on investor sentiment. If there is limited interest in MBS then interest rates go up to attract new investors. Higher interest rates are an incentive for investors to buy MBS.

Economic Outlook is another factor that influences mortgage interest rates. In bad economies, unemployment numbers go up. There is a direct correlation between unemployment rates and foreclosure rates. Increased foreclosures devalue the underlying MBS and that is a deterrent to investors. If a poor economic outlook creates a demand squeeze then rates may rise. Remember, if investors are not buying MBS interest rates are raised to entice new money.

Volume contributes to the movement of mortgage interest rates and is unique to MBS. Unlike stocks where availability is definable, in any given month there is no way to know for sure exactly how many mortgages will be originated, packaged, and sold to investors. Rates have to be adjusted to counterbalance an excess or a shortage.

Intermediate Term Bonds are considered the chief rival to MBS. Although MBS are typically composed of 30 year fixed rate mortgages, very few of these notes are carried to maturity. In fact most 30 year mortgages are sold or refinanced before year 10. That is why MBS are compared to the 10 year Treasury note. If an investor is looking for shelter from stocks they turn to safer instruments such as MBS and bonds. Treasury bonds are guaranteed by the U.S. government and are safer than MBS, so MBS have to offer a higher yield to compete for investor dollars. That’s why there is a loose relationship between the pricing of mortgage interest rates and Treasury bond prices.

Lasting Inflation (erosion in the purchasing power of money over time) effects mortgage interest rates because inflation affects returns. If an investor buys a MBS with a 4% return a 2% inflation rate cuts that return in half. Therefore, rates have to be raised to 6% to get a return of 4% after inflation is accounted for. Inflation and mortgage interest rates move in the same direction.

Mortgage interest rates are near impossible to predict. While it is easy to recognize what factors exert pressure on mortgage rates how much pressure is exerted by each factor is harder to ascertain. For more information on mortgage rates and how they move contact a mortgage professional.