Mortgage FAQ

5. Why do mortgage rates change?

To understand why mortgage rates always seem to be changing, you must first understand why interest rates change in general. It is important to remember that there are many interest rates.

• Prime rate: The rate offered to a bank's best customers.
• Treasury bill rates: Short-term debt instruments used by the U.S. Government to finance its debt. They are more commonly called T-bills and come in denominations of 3, 6, and 12 months. Each T-bill has its own interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate).
• Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance its debt. Treasury notes come in denominations of 2, 5, and 10 years.
• Treasury Bonds: Long-term debt instruments used by the U.S. Government to finance its debt. Treasury bonds come in 30-year denominations.
• Federal Funds Rate: Rate banks charge each other for overnight loans.
• Federal Discount Rate: Rate New York Fed charges to member banks.
• Libor:London Interbank Offered Rates; the average London Eurodollar rates.
• 6 month CD rate: Average rate you get when you invest in a 6-month CD.
• 11th District Cost of Funds: Rate determined by averaging a composite of other rates.
• Fannie Mae-Backed Security rates: Fannie Mae pools large quantities of mortgages and creates securities with them. They are then sold as Fannie Mae-backed securities. The rates on these securities strongly influence mortgage rates.
• Ginnie Mae-Backed Security rates: Ginnie Mae also pools large quantities of mortgages to create securities with them. They are sold as Ginnie Mae-backed securities. The rates on these securities influence mortgage rates on FHA and VA loans.

Interest-rate movement is based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do the interest rates. Because there are more buyers, sellers can command a better price, meaning higher rates. If the demand for credit decreases, so do the interest rates. Because there are now more sellers than buyers, buyers can command a better price, meaning lower rates. Interest rates move higher when the economy is expanding, because of the heightened demand for credit. Interest rates go down when the economy is slowing, because the demand for credit is also decreasing.

The basic concept of interest rates is:

• Bad news for the economy (i.e. slowing down) equals good news for interest rates (i.e. lower rates)
• Good news for the economy (i.e. growing) equals bad news for interest rates (i.e. higher rates)

The biggest factor driving interest rates is inflation. Higher inflation is associated with a growing economy. If the economy is growing too strongly, the Federal Reserve will increase interest rates in an attempt to slow the economy down, thereby reducing inflation. Inflation is the result of the prices of goods and services increasing. When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can raise their prices. Therefore, a strong economy results in higher real-estate prices, higher rents on apartments and higher mortgage rates.

Mortgage rates tend to move in the same direction as interest rates. However, actual mortgage rates are also based on supply and demand for mortgages, but the supply/demand equation for mortgage rates can differ from the supply/demand equation for interest rates. As a result, mortgage rates may move differently from other rates. For example, one lender may be forced to close additional mortgages in order to meet a commitment they have made. This might force them to offer lower mortgage rates, even though interest rates have moved up and they should be following suit with their mortgage rates.

In addition, there is an inverse, and often confusing, relationship between bond prices and bond rates. When bond prices increase, interest rates decrease, and vice versa. This is due to the fact that bonds tend to have a fixed price at maturity--typically $1000. If the price of the bond is currently at $900, and there are 10 years left on the bond, if interest rates start increasing, the price of the bond will start to decrease. The higher interest rates will cause increased accumulation of interest over the next 5 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.

Effect on Economic Data on Rates

Number of arrows indicates potential effect on interest rates.

1 arrow=least effect
5 arrows=max. effect

Economic Event	Effect on Interest Rates	Significance of Event
Consumer Price Index (CPI) Rises		Indicates rising inflation.
Dollar Rises		Imports cost less; indicates falling inflation.
Durable Goods Orders Increase		Indicates expanding economy
Gross National Product Increases		Indicates strong economy
Home Sales Increase		Indicates strong economy
Housing Starts Rise		Indicates strong economy
Industrial Production Rises		Indicates strong economy
Business Inventories Rise		Indicates weak economy
Leading Indicators (LEI) Increase		Indicates strong economy
Personal Income Rises		Indicates rising inflation.
Personal Spending Rises		Indicates rising inflation.
Producer Price Index Rises		Indicates rising inflation
Retail Sales Increase		Indicates strong economy
Treasury Auction Has High Demand		High demand leads to lower rates
Unemployment Rises		Indicates weak economy

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