Mortgage Rates and the Bond Market June 2012

Friday, June 8, 2012

Many different factors affect mortgage rates, from stocks to inflation to the Federal Reserve to Americans themselves and their buying and spending habits. But it is bonds and the bond market that are a primary influence on mortgage interest rates. It’s a complex relationship that we’ll try to simplify here. For more information, please contact us directly to discuss this economic relationship.

To put it simply, a bond is a loan that the investor — you — makes to the borrower, which is a private company or a government entity such as the federal or local governments or Fannie Mae or Freddie Mac. The borrower promises to repay the principal along with interest on a specified date, often called the date of maturity. A bond generally matures a year or more from the date of issue.

Bonds are considered relatively safe, or stable, investments because the rate of return is fixed. High-risk bonds, like those based on subprime mortgages, have high returns. Mortgage-backed bonds are generally considered medium risk, and Treasury bonds are considered the safest bonds as they are guaranteed by the federal government.

Bond prices and interest rates are inversely related: as one goes down, the other goes up. However, bond yield — the interest earned — and interest rates move in the same direction: when one goes up, so does the other. So when a Treasury bond has a high yield, overall interest rates are also higher.

In general, bonds are sold before they mature, and their yields can change daily. When the economy is strong and the stock market is a popular investment, less people buy bonds, and their value goes down, as well as their price. But if there is a lot of demand for a bond, it can be sold for a higher price — even above face value — and the interest or yield it pays will decline because the agency it is purchased from will only pay the face value plus the interest rate stated at the time of purchase.

 So if bond prices drop, that means demand for bonds has also dropped, and then the yields must increase in order for the bond to have the proper payout guaranteed at the time of purchase. When the yields increase, interest rates increase, and your mortgage loans’ interest will also increase, meaning your home purchase will be more expensive. That is why when the economy is stable and stocks are doing well, buying a home is costlier.

 As you can see it is an incredibly complicated relationship. If you have more questions about this or any other aspect of mortgage financing, please contact us for a no-obligation consultation. We are happy to help you!

972/396-9143  The Covenant Team.

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