Mortgage rates fluctuate depending on changes in key economic factors that interact to determine a specific rate at a particular point on the economic cycle. Lenders routinely monitor economic activity related to the mortgage market to try to maximize returns from lending activity during periods of strong and weak economic growth.
Changes in economic growth can cause an increase or decrease in interest rates. This has implications for mortgage lenders who adjust their lending rates to meet their rates of return on mortgages to stay profitable. For example, an increase in economic growth commonly generates an increase in the general level of interest rates in the economy, which puts upward pressure on mortgage rates. However, the opposite is true when a decrease in economic growth brings interest rates down and lenders adjust their lending rates accordingly.
To stay ahead of economic growth and decline, mortgage lenders often study economic conditions to gauge how the economy is likely to perform in the short- and long-term. Forecasting economic conditions lends insight into how interest rates are likely to behave. As a result, mortgage lenders can accommodate economic changes like inflation. For example, sustained economic growth we know encourages inflation. If inflation is expected to occur, lenders adjust their mortgage rates to keep up with inflation.
Government policy also influences mortgage rate fluctuations. Specifically, the Federal Reserve is a key component in controlling interest rates and reining inflation by adjusting the supply of money in the economy. If economic growth generates too much inflation, the risk to the economy is that purchasing power deteriorates. To prevent a costly drop in the purchasing power of money, the Federal Reserve buys a calculated amount of Treasury bonds on the open market to inject money into the economy. The effect of additional money helps decrease interest rates to more sustainable levels.
Mortgage rates also fluctuate according to certain economic indicators. For example, the federal funds rate is the interest rate banks pay when they borrow from each other, usually overnight, to meet federally mandated reserves that must be stored in banks. The federal funds rate forms the basis on which banks determine their interest rates. Other indicators may include both the Consumer Price Index and the Producer Price Index, which measure changes in prices on products purchased by consumers and producers.
Mortgage Market Conditions
Mortgage interest rates are also influenced by developments in the real estate industry that help indicate the strength on the demand for mortgages. For instance, mortgage lenders monitor the construction and sale of new homes. If sales and building activity increases, lenders expect the demand for mortgage borrowing to increase, pushing mortgage rates upward. Conversely, declining sales and construction of new homes indicates a weaker demand for new mortgages, driving interest rates lower.
- "Financial Markets and Institutions;" Jeff Madura; 2009
- "The Economics of Money, Banking and Financial Markets;" 2007
- eyeglasses on business magazine close up image by Nikolay Okhitin from Fotolia.com