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Why Mortgage Rates Go Up and Down

Mortgage rates go up and down depending upon changes in major economic factors. They interact in a way that determines a certain interest rate at a particular time. Mortgage lenders keep a close eye on economic activity that affects the mortgage market so they can maximize loan returns during strong and weak economic periods.

The major factors that influence mortgage rates include the following:

Economy

Increases or decreases in economic growth will have an effect on mortgage interest rates. This has major implications for lenders who adjust rates to meet mortgage rates of return to keep profitable. A good example is that strong economic growth usually causes an increase in interest rates overall. This will usually put pressure on mortgage rates to go up.

However the opposite also is true: When there is lower economic growth, interest rates generally decline and mortgage lenders will normally decrease their rates.

Economic Forecasts

To keep abreast of what is going on in the economy, lenders always study current economic conditions to determine how the economy will likely perform in the short term and in the long term. By forecasting economic conditions, lenders gain insight into how interest rates may go up or go down in specific time periods.

That is why lenders are able to deal with economic fluctuations, such as inflation. Strong economic growth over several years will encourage inflation. If lenders think that inflation is going to occur in the future, they will adjust their rates to keep pace with inflation.

Money Supply

US government policy has a strong influence on mortgage rates. For example, the Federal Reserve is a major component in the US economy in controlling general interest rates and preventing inflation by adjusting the money supply.

If strong economic growth encourages a lot of inflation, people's purchasing power drops and the economy is put at risk. To stop a dangerous drop in money's purchase power, the Federal Reserve will purchase a certain number of US Treasury bonds and inject that money into the US economy. The additional money in the economy will help to drive down interest rates and lower inflation.

Economic Signs and Indicators

Mortgage loan interest rates also will change according to various economic indicators. For instance, the federal funds rate is what banks pay when they are borrowing money from one another. They usually are borrowing this money overnight so they meet federally required reserves that banks must hold.

The federal funds rate is what banks use to determine their interest rates. Other important indicators in the economy are the Consumer Price Index and the Producer Price Index. These measure price changes in products that are bought by both consumers and producers.

Mortgage Market

Interest rates on mortgages also are affected by what is going on in the real estate industry. Changes in the real estate industry help to provide signs of the strength or weakness of the demand for mortgages. For example, lenders carefully monitor construction and sale of new houses. If the sale of homes and building of homes increases, lenders will assume that there will be an increase in demand for mortgages. This will tend to increase interest rates.

On the other hand, if sales and construction of new homes fall, this indicates a weaker demand for loans. This will drive rates down.

Other things to keep an eye on to know where mortgage rates are headed include:

  • Watch the bond market. When bond rates go up, which is called the bond yield, mortgage interest rates will go up. This should not be confused with bond prices; these have an inverse relationship with mortgage interest rates. Investors invest in bonds as a safe investment when the economy is not doing well. If purchases of bonds go up, the yield will fall, and mortgage rates fall. Conversely, if the economy is looking strong, investors usually buy stocks. This forces bond prices lower and will push the yield and mortgage rates higher.
  • If your stock portfolio is generally rising, it is a good bet that mortgage rates will rise as well. A rising stock market usually means a stronger economy, which leads to higher interest rates.
  • Watch what the Federal Reserve says about the economy. Depending upon what their latest economic report states, mortgage rates can swing up or down.
  • Inflation has a big effect on mortgage rates. If there is a strong fear in the economy of inflation, interest rates will rise to reduce the supply of money. If on the other hand there is little worry about inflation, rates will usually drop.

Final Thought

When there is a general rise in economic activity, you can expect mortgage rates to rise. When there is a decline in economic activity, expect mortgage rates to fall. Also remember that the biggest effect on mortgage interest rates is you, the borrower. Someone who is deemed a good risk by the lender will enjoy the lowest interest rate. A person with poor credit will usually pay a much higher interest rate, regardless of what is occurring in the broader economy. Article was written by Jenifer Stone