Betting on the Economy: How Bonds Drive Mortgage Rates

Buying a home is rarely a snap decision. Most people spend at least 18 months lurking on Zillow and going to open houses before ever calling a mortgage broker or REALTOR® — but by the time they do, they’re ready to move. Literally. But sometimes the market has other things in mind.

When I get calls about Caliber’s rates, it’s almost always from someone who is on day one of their home buying journey.

The conversation usually goes like this:

BUYER: What’s your best rate for a 30 year fixed? I’m putting 20 percent down, and I have a FICO of 782.

ME: Are you buying a home in the next week?

BUYER: No. Maybe in six months or so.

ME: Well, then it depends.

BUYER: On what?

ME: You, the U.S. and world economy, the stock market, bond traders and the precise day you write your offer.

Now, I’ll admit, that’s not an easy or popular answer. But it’s honest, and based on the reality that bonds drive the mortgage market.

 

Bonds 101

Mortgage rates move in tune with the bond market. If you’re not a bond expert (like 99.9987689 percent of the world), bond pricing can seem (alright, is) confusing. But here are a few simple principles to keep in mind:

  • Bonds are a big fat IOU — where you, as the bond buyer, lend your money to the borrower at a guaranteed interest rate and term. Most people think the safest bonds of all are issued by the US government (and these bonds are called Treasuries – go figure).
  • When the bond matures, you get the face value of the bond, and while you hold the bond, interest payments.
  • Bonds with a longer term (like 10 years) tend to pay a higher interest rate (or yield). That’s because you’re taking a risk by tying up your money for a long time (more on this in a minute).
  • If interest rates rise higher than your bond’s rate, your bond will trade at a discount (or below par). No one likes this. That’s why inflation is the arch enemy of bonds: Prices rise, but the purchase value of money falls. And that’s when people sell bonds.

 

Milking It

Let’s put this in real terms. Say you bought a $10,000 bond in 2006, with a three percent yield (or rate) for 10 years. Sounds good, right? You’re making $300 a year in interest, or $3,000 on your $10,000 investment.

But … here’s where it gets tricky.

Let’s say you take your $300 to the grocery store in 2006 and buy 100 gallons of milk at $3 at gallon. But in 2007, the price of milk goes up to $3.87. Now you can only buy 77 gallons with your $300. If you’d known that the cost of milk was going to shoot up so much, would you have agreed to such a low rate on your bond? Probably not.

In fact, for you to be willing to take the risk, you’d need a return of 3.875 percent so you can still buy your 100 gallons of milk.

Mortgage bonds (which are essentially big bundles of mortgages assembled into a single bond) trade with the very same behavior in mind. If bond investors think the price of goods and services are likely to rise, they will not buy a bond unless it pays them enough yield to make it worth the risk.

 

Trumped

All you need to do to see this in practice is to look at what’s happened to mortgage rates since Donald Trump was elected in November, 2016.

Lots of investors believe that now that the Republicans control the Senate and House, the country will change to a pro-business, deregulated, tax-friendly climate. Wall Street thinks that might lead to more jobs, higher wages and  … you guessed it, inflation. Immediately after the election, lower rate bonds sold off quickly, and new bonds have a new, higher interest rate.

In fact, according to Freddie Mac, average mortgage rates were 3.55 percent the day of the election. In a matter of days, they jumped to four percent, and a few weeks after that, 4.3 percent. While it’s worth noting that these are still historically low rates, it was a big surprise for many buyers.

Freddie Mac Rates

 

That’s why you can’t predict months in advance what your mortgage rate will be. But you can call us to talk about the market, so you have a full understanding of where things are headed.

We can’t control the market, but we can make sure you get the very best mortgage you can when you decide to buy.

We will help you understand your options, so you get the right type of loan for your situation. Mortgages are not a one-size-fits-all product, particularly when rates are in flux and you’re buying your first home (or your fifth). We’ll identify a rate lock strategy for you that helps you achieve your goals, and keep you informed every step of the way. We wouldn’t have it any other way.