Why Do Mortgage Rates Respond to Economic Events?

Q: Why are mortgage rates tied so closely to economic and financial market events?

A: When a person borrows money from a lender, the person must sign a promissory note promising to repay the home loan and a mortgage note (or deed of trust) to serve as collateral for the loan. The bearer of these notes has a legal claim to the property until the mortgage loan is either paid in full or refinanced. When a lender has loaned out all of its available funds, the lender will often raise money by selling groups of these notes (mortgage loans) to investors. The selling of mortgage loans to investors is referred to as the `secondary mortgage market.' In order to attract investors, this secondary mortgage market must be competitive with similar investment markets. Since a mortgage loan is a long term debt, the Treasury bond market (debt issued by the federal government) is used as a benchmark for determining appropriate value.

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Q: Why is bad economic news good news for mortgage rates?

A: Inflation is the primary factor that affects the Treasury bond markets and interest rate levels. Treasury bond investors do not like inflation because it eats away at the value of their fixed return investments. When the economy slows down, the threat of inflation is subdued and investors become more comfortable investing in long term debt. This is the reason the Treasury bond market rallies (bond prices move higher) on weak economic news. When the price of a Treasury bond moves higher an investor is forced to pay more for this investment, so its yield (return on investment) to the investor declines. When the yield on Treasury bonds decline the yield on all similar investments (including mortgage loans sold in the secondary market) decline as well. If a lender can sell mortgage loans at a lower interest rate to investors, they are likely to pass on these lower rates to you, the borrower.

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