What Causes Mortgage Rates to Change?

Tim Sickinger, Principal, Ladd Financial   

Why have mortgage rates varied so much recently?

Interest rates have been moving around quite a bit this last six to twelve months, and primarily that's due to what we're all hearing is the credit crunch. The credit crunch in a nutshell is the lack of banks willing to lend money to consumers. We've all heard about the Federal Reserve lowering interest rates, which would lead the average individual to believe interest rates would fall, but that hasn't necessarily happened.

I need to tell my customers quite often that the Federal Reserve only controls short-term interest rates, short-term Treasury rates, actually. They really do not control long-term Treasury rates, nor do they control mortgage rates. Long-term Treasury rates and mortgage rates are really concerned, are really controlled — basically, they move based on expectations, what people believe is going to happen in the future in terms of interest rates.

With the price of gasoline going up, with the price of food going up, I think it's quite obvious that we have run into a bout of inflation, and interestingly enough, the government removes those two pieces from their inflation number. But the reality of it is that it makes up — most of people's spending money goes toward food and gas or energy in some way, shape, or form. Those inflationary things that are happening within our economy are now starting to really bite into people's pocketbooks.

So the average individual, their expectation is that things are going to cost more money in the future. That cost, ultimately that expectation, gets built into what they think interest rates are going to do in the future. It's a little more complicated than that, because it has to do with traders and what traders believe. Traders trade mortgage bonds and Treasuries based on what, really, consumers believe, so it's kind of about what they think long-term interest rates are going to do. So that's one of the things that's been happening.

Now the economy, we keep getting sort of mixed news. We'll get good news about the economy, and then we'll get bad news about the economy. Good news about the economy potentially is inflationary, so that could drive interest rates up. People sometimes don't understand that. Bad news about the economy is potentially deflationary, which could drive rates down. But when the Fed raises and lowers interest rates, it really has very little to do with what's going to happen in the long-term mortgage market. About half the time, long-term rates go up; about half the time, long-term rates go down. So it's a complicated question; there's not an easy answer.

Tim Sickinger is a Principal at Ladd Financial, a mortgage lending firm in Westport, CT.