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What's the Rate Today? (Use a Crystal Ball or....)

Old Article (2002), but still applicable

(...though usually the 10-year Treasury note benchmark now is closer to 3 percentage points spread...see below):

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"If you're going to purchase a home or refinance, it's a good idea to grasp how mortgage interest rates are linked to the bond market. Understanding the relationship can give you a heads up on when rates will be moving higher or lower.

Banks and other lenders use the bond yield on the government's 10-year Treasury note as the benchmark for setting mortgage interest rates.

There's always a spread between the Treasury note bond yield - which is the yearly return paid to bondholders - and what lenders are charging as interest for a home loan.

The spread lately has been.....

....around 2 percentage points (note for Oct. 2008...closer to 3 points!). For example, say the yield on the 10-year Treasury is 3.4 percent; then mortgage rates will be around 5.4 percent (2008 = 6.4%).

"In the world of bonds, everything is priced as a spread over Treasuries," said Greg McBride, the senior financial analyst at Bankrate.com in North Palm Beach, Fla. "Because mortgages are in large part sold to investors who package them together into large bonds known as mortgage-backed securities, the rates on those bonds and on mortgages very closely track the yield on benchmark Treasury securities."

How do lenders determine the spread? They get guidance from Fannie Mae and Freddie Mac, the major purchasers of mortgages, because they have a required net yield.

"They tell banks, if you're going to sell us a mortgage, this is what the investor (of a mortgage-backed security) has to earn. It gives lenders a starting point," Mr. McBride said.

As you track the Treasury yield, keep in mind that bond yields and prices move in opposite directions - when one goes up, the other goes down. If Treasury bonds are in great demand, their prices go up, while the return they pay investors - the yield - goes down.

Lately, bond prices have been going up as investors, worried about the uncertain economy, seek safer investments than the stock market and snap up government-guaranteed Treasuries, sending their yields southbound.

"When Treasury yields go down, mortgage rates eventually follow," said David Lereah, the chief economist at the National Association of Realtors in Washington. "Sometimes it's the same day, sometimes it's a couple of days later," depending on how often the bank or mortgage lender prices their rates. Some do as often as twice a day.

Treasury prices and yields and mortgage rates also fluctuate with the stock market and economic news. It's odd, but what's bad for the stock market and the economy is good for the bond market and mortgage rates.

"Economic news that shows a strengthening economy would lead investors to feel more confident about the direction of the economy and make them willing to take on more risk, so they move money out of bonds and into stocks," Mr. McBride said.

That would send bond prices lower and their yields higher, pushing up mortgage rates.
"Conversely, if economic data indicated further slowing, investors become risk averse, moving money out of stocks and into bonds," sending bond prices higher, and yields and mortgage rates lower, Mr. McBride said.

How does all this tie into the hype about whether the Federal Reserve and Chairman Alan Greenspan (2008 = Ben Bernanke!) will cut interest rates? It doesn't. Mortgage rates are not tied to the federal funds interest rate, the rate banks charge each other for overnight loans to maintain their required reserves. That's the rate that the Fed directly influences.

"That overnight lending rate is a benchmark for short-term credit products, such as home equity loans, auto loans or credit card rates," not for mortgage rates, Mr. McBride said."

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This page contains a single entry from the blog posted on October 31, 2008 3:44 PM.

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