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Mortgage interest rates are driven by the mortgage backed securities market (MBS).  These are the securities that purchase loans from mortgage lenders and are traded on Wall Street.  While there are many factors that drive the MBS market, they most closely trade at a spread tied to Government Treasuries.  In short, investors want higher returns on their money for investing in MBS vs. treasuries because government bonds are backed by the US government, while MBS do not.  Let’s use a dollar for the purposes of illustrating how a spread works, if a treasury costs an investor $1. than an MBS might cost $1.20.  The spread is .20.  This spread can vary based upon many factors on Wall Street and the economy in general.

One commonly heard question is why mortgage rates have not fallen as much as government Treasury yields. There are two main reasons. First, mortgage-backed securities (MBS) have prepayment risk (called duration) while Treasuries do not. When people refinance, their loans are removed from MBS and the investor gets paid off early. This makes MBS less valuable to investors relative to Treasuries during periods of declines and more valuable during periods of increases. In other words, mortgage rates rise and fall more slowly than Treasury yields due to the basic properties of prepayment risk. Second, the large mortgage lenders which purchase loans and set the mortgage rates offered to the public have the capacity to process only so much business at one time. When there is more demand for loans than these firms can handle, they have less incentive to pass along the lowest possible rates to customers.  This often happens when rates are very low causing a refinance boom.  Here are some actual figures which illustrate these outcomes. For the week ending February 28, 2020 10-year and 30-year Treasury yields fell 25 to 30 basis points. By contrast, the Mortgage Bankers Association (MBA) reported that average jumbo loan rates were unchanged during that period, while average 30-year conforming loan rates only fell by about 15 basis points.

Another question is why when The Fed. cuts rates, often by a quarter or half percent, do mortgage rates not decline by the same amount.  This answer is much simpler. The Fed sets only short-term rates, and all of those do drop by roughly 50 basis points (car loans, credit cards, home equity loans, etc.). However, long-term rates such as mortgage rates are set and influenced by a wide range of factors and are not tied to movements in short-term rates.  Additionally, both the treasury bonds and MBS securities trade on investor’s future projections so when the Fed raises or cuts rates, it’s often priced into the market well in advance of the Feds.actions.