Why Mortgage Rates Track Bonds Not The Fed

Mortgage rates are routinely described as being set by the Federal Reserve. They are not, and the periods when the two move in opposite directions make the point clearly.

Where a mortgage rate comes from

Most American mortgages are not held by the lender that originated them. They are pooled into securities and sold to investors in a large secondary market.

The rate offered to a borrower therefore reflects what investors will pay for the resulting security, plus the costs of origination and servicing.

Those investors are comparing the security against other long-dated fixed income, which is why the ten-year Treasury yield is the customary reference point.

The spread over Treasuries

Mortgage rates sit above comparable Treasury yields by a spread that compensates investors for credit considerations and for the uncertainty of when the loan will be repaid.

That spread is not constant. It widens when demand for mortgage securities weakens or when rate volatility rises, and it narrows when conditions reverse.

A borrower can therefore face a higher rate even when Treasury yields have not moved, purely because the spread has changed.

Prepayment is the complication

A borrower may repay a mortgage at any time, through refinancing or moving, which means the investor does not know how long the security will pay.

When rates fall, borrowers refinance and investors receive their money back precisely when reinvestment options are least attractive.

This asymmetry means mortgage securities lengthen when rates rise and shorten when rates fall, the opposite of what a holder would prefer, and investors demand compensation for it.

Why the central bank connection is indirect

Policy sets an overnight rate, while a thirty-year mortgage is priced against expectations extending far beyond any current policy setting.

Long yields therefore respond to the anticipated path of policy and to inflation expectations, both of which can move before or against an announced decision.

A widely anticipated policy change is often already reflected in long yields, so the announcement itself produces little movement in mortgage rates.

What varies borrower to borrower

Advertised averages describe a particular profile. Actual offers depend on credit assessment, down payment, property type, loan size and the individual lender's pricing.

Points paid at closing exchange upfront cost for a lower rate, which makes headline rate comparisons incomplete without the accompanying terms.

Loan terms and disclosure requirements vary by state and change over time, and the loan estimate provided by a licensed lender is the document that governs.