When Do Mortgage Rates Fall?
- Mortgages are long-term loans used to finance the purchase of big-ticket items such as real estate. The interest rate at which the mortgage is repaid is an important contributor to overall affordability. In short, mortgage rates fall when the supply of cash banks are willing to loan for long periods of time exceeds the demand for such cash. To measure these influences, a number of benchmarks are used to set mortgage rates. Prevailing rates often fluctuate, so buyers who can anticipate these changes can often capture a better deal.
- Though the Federal Reserve can set its benchmark target rate by fiat, rising or lowering by declaration, the movements of the Fed don't always directly impact mortgage rates. In fact, for much of 2008, as the Fed lowered its interest rate, mortgage rates actually rose. The Federal Reserve only sets the rate for overnight loans of fed funds to specific broker/dealers, and these rates do not directly determine mortgage rates. They can potentially, however, impact the amount of cash banks are willing to lend.
- Interest rates are often compared among loans of similar maturity. Since most loans are for 10, 15 or 30 years, a common benchmark for mortgage rates was the yield on a 30-year Treasury bond. Of course, the mortgage is given at a premium to the government bond, usually a spread of two points or more. Movements in the Treasury market are linked to changes in the Fed funds rate, but their price and yield are set in an open market, so other factors apply. Yields on the long bond decline when fear of inflation is low, when risk aversion in the market is high, and when investors see few other reasonable opportunities for returns elsewhere.
- A more common benchmark for mortgages that originated in the 20th century is the London Interbank Offered Rate, or LIBOR. This rate is determined daily by auction and represents the cost of short-term loans between banks. Unlike the Fed funds rate, it is not set by committee and, unlike Treasury yields, is not established in a completely open market. LIBOR is a sort of hybrid that represents the demand for overnight cash by banks versus the available supply of cash banks are willing to lend. The prevalence of LIBOR as an international benchmark indicates the global nature of modern money markets.
During the credit crisis of 2008, several large banks failed, and this called into question the solvency of all banks. Those institutions with money to lend became increasingly unwilling to lend out of fear they would never get their money back, a concern called counterparty risk. The fear of counterparty risk kept supply of cash low and therefore LIBOR remained stubbornly high, even as investors took down the yields on Treasuries and central banks lowered their own targets. As confidence returned to the system, and more cash made available to loan, LIBOR was seen to decline, and with it, mortgage rates.
