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Mortgage Rates: How the Interest Rate Rise Affects Mortgages

Author: Daniel Jackson

Of all the areas of finance and money-lending, perhaps nothing hits closer to home (literally) than the prevailing mortgage interest rate. After all, your ability to buy a new residence, or to refinance the loan on your current one, depends on it. So how do these rates operate, and what affects them?

How It Works

The quick and dirty answer: They're constantly changing, depending on what the government is doing and how Wall Street reacts.

Now, the slow and clean answer. You probably know that much of what happens in the world's financial markets happens in real time. When some new piece of news hits, the stock exchanges and other investment markets react within milliseconds – yes, milliseconds. With the help of highly sophisticated computers, investors can move money from one place to another to profit from the information faster than you can draw breath. That means that the interest rate your mortgage lender offers you could be higher or lower based on something that happened just minutes ago.

Take, for example, the current New York Stock Exchange downturn. The year 2016 has been a depressing start for Wall Street investors. The Dow Jones Industrial Average is down more than 9% and has logged multiple days of triple-digit point moves. That has caused investors to dump equities and equity-based funds, and move their money to safer markets. One of those is the U.S. Treasury market. When money is poured into Treasury bonds, notes and bills, their yields fall.

Guess what the primary driver of mortgage rates is? The 10-year Treasury note.

If you're in the market for a mortgage right now, you're seeing rates about 0.06% lower – or six basis points if you want to sound smart. This is a key reason why, the week of Jan. 11, refinance applications jumped a seasonally adjusted 19% from the previous week. Six basis points sounds like a small amount. But that 0.06% will dramatically affect the amount of money you pay in interest, if you're taking out the proverbial, fixed-rate 30-year mortgage (assuming you hold the loan for the full 30 years). (For details on this most popular of of home-financing vehicles, see The Pros and Cons Of A 30-Year Mortgage.)

Armed with this knowledge, you now know why mortgage rates didn't instantly rise when the Federal Reserve raised interest rates 0.25% last year. Your credit card's APR instantly jumped because credit cards are tied to the prime lending rate. But since mortgage rates are tied to the 10-year Treasury, market reaction at the time actually caused T-note rates to drop, which caused mortgage rates to fall with them, to as low as 3.76%. (See What to Expect From Mortgage Rates in 2016 for details.)

They're rebounded a bit since, though some borrowers with high credit scores and the cash to make significant down payments can still get a mortgage for under 4%. But even today's 4% rates are quite a bargain, compared to the beginning of this century, when rates were 8% or more; or the early '80s, when rates were as high as 18%. Affording a home has never been so easy.

What About Home Equity Loans?

Some shorter-term loans tied to your home aren't tied to the 10-year Treasury. If you're in the market for a home equity line of credit, or HELOC, you're not concerned with Treasuries. You want to watch the prime rate, just as you would with your credit card. When the prime changes, so does the interest rate on HELOCs. When the Fed raised rates at the end of last year, HELOCs repriced. Since the Fed is forecasted to continue raising rates this year, consider your timing for applying for an adjustable rate loan: Earlier might be better.

HELOCs aren't the only type of loan that isn't tied to the 10-year Treasury. Other adjustable-rate mortgages might follow other benchmarks, such as the London Interbank Offered Rate (LIBOR). Before you sign the contract for any home loan, make sure you understand how the interest is calculated, whether or not it will change over time, and, if so, to what extent it could fluctuate.

The Bottom Line

What does all of this mean for mortgage rates in 2016? Nobody knows what the markets will do this year, though we do know they're not off to a good start, causing rates for homeowners (or would-be homeowners) to stay on the low side. But don't make rate levels the only thing driving your decision to finance or refinance. Trying to time the mortgage-rate market probably isn't going to work out in your favor. As some lenders like to say to their clients: Don't risk a dollar to save a dime.

However, if you're in the market for a home right now, locking in your rate while the major investment markets are weak definitely makes sense. How long a window you have, nobody knows.

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