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Whenever you hear people trying to predict whether mortgage rates will go up or down in the future, you may hear them use bond prices as a reference. But how do bonds affect mortgage rates? Follow along below to see how the bond market inversely affects mortgage rates and what that means for you.
Orion's brokers and our AEs know that mortgage rates, and interest rates in general, change every day, and even during the day. Last week they hit the highest rates since mid-February. Our AEs are being asked, “Why?'
Mortgage rates have been volatile for a few weeks now. Bond yields spiked higher mid-week when President Donald Trump's new tariffs on dozens of countries went into effect. Yields dropped when Trump lowered the tariff rate on most countries hours later. Tariffs on Chinese imports, however, currently stand at 145 percent… but who knows where that will be tomorrow, or next week, or next month.
Bond prices and mortgage interest rates have an inverse relationship with one another. That means that when bonds are more expensive, mortgage rates are lower.
The reverse is also true – when bonds are less expensive, mortgage interest rates are higher.
At first glance, this might seem like an illogical correlation. When interest rates are higher, more people will want to buy bonds – why don’t higher interest rates push bond prices up?
To understand, let’s look at the supply and demand of the secondary bond market.
Last week, a roiling stock market briefly sent investors into the safety of government-backed U.S. bonds, causing yields to drop. But that didn’t last. Days later, amid a stabilizing stock market, escalating tariff threats and renewed inflation concerns, investors began dumping bonds, driving yields higher.
Then on Wednesday, Trump announced a 90-day pause that reduces tariffs for most countries — except China, which now faces a 145% tariff, “effective immediately.” A baseline 10% tariff still applies to imports from more than 180 countries.
So far, both bond yields and mortgage rates remain high. Mortgage rates tend to follow the 10-year Treasury yield decently quickly, sometimes within a couple of days, although exact timing can vary.
Bonds and mortgage rates share an inverse relationship, which means that when bond prices fall, mortgage rates tend to rise. To grasp this concept, consider it from an investor's perspective.
As an investor in the bond market, you might weigh the option of investing in U.S. Treasury bonds or mortgage-backed securities (MBS). The yield on Treasury bonds is set by the U.S. Treasury Department, while the yield on MBS is influenced by the blend of mortgage premiums and interest payments bundled into an MBS product.
Imagine you have a $1,000 Treasury bond with a 4% annual interest rate. A year later, you wish to sell the bond on the secondary market, but the Treasury has since raised bond interest rates. Now, other investors can invest the same $1,000 with the Treasury for a 5% annual return, reducing demand for your bond. To attract buyers, you decide to sell your Treasury bond for $900, enabling you to access liquid funds quickly, and the buyer enjoys a higher yield over time.
This decision to lower your bond price impacts mortgage rates. Entities selling MBS in the secondary market aim to attract the investor who paid $900 for your bond. To achieve this, they must offer higher interest rates on MBS to make them more appealing. Consequently, they raise mortgage interest rates to provide investors with a better return. These rates are set slightly above Treasury bond rates, which serve as a benchmark due to their perceived stability. Mortgage rates are slightly higher to account for the greater risk of mortgage defaults compared to Treasury bonds.
The U.S. Treasury bond is perhaps the most recognized type of bond. Essentially, purchasing a Treasury bond means lending money to the U.S. government in exchange for a fixed interest payment. For instance, if you purchase a $1,000 Treasury bond from the U.S. Treasury Department with a 5% annual fixed interest rate and a 10-year maturity, the government will pay you $50 in interest each year and return your $1,000 principal at the end of the term. Due to the backing by the full faith and credit of the U.S. government, these investments are perceived as virtually risk-free, albeit with relatively modest returns.
Similarly, corporations can issue their own bonds under comparable conditions. By lending money to a corporation, you receive interest payments and the principal back at maturity. The key difference between corporate bonds and Treasury bonds lies in the risk involved, as corporations are more likely than the government to default. However, this increased risk is often accompanied by higher returns.
Another investment product that competes with Treasury and corporate bonds in the secondary market is the mortgage-backed security (MBS). MBS are collections of mortgages bundled together and sold to investors, who receive portions of the principal and interest payments from the mortgages. When a homebuyer takes out a mortgage, the lender typically sells it to a government-sponsored enterprise (GSE) like Fannie Mae or Freddie Mac. These GSEs then package numerous similar mortgages into a single MBS and sell it to investors.
There are a few personal factors that influence how much you’ll pay in interest on your mortgage loan. Your down payment, credit score and loan type all affect your final interest rate. However, there are also many hidden factors that influence market interest rates as a whole.
One of those factors is the bond market. Let’s examine how bond rates influence mortgage rates and which types of mortgage rates are influenced by the bond market.
Bond prices and mortgage interest rates have an inverse relationship with one another. That means that when bonds are more expensive, mortgage rates are lower.
The reverse is also true – when bonds are less expensive, mortgage interest rates are higher.
At first glance, this might seem like an illogical correlation. When interest rates are higher, more people will want to buy bonds – why don’t higher interest rates push bond prices up?
To understand, let’s look at the supply and demand of the secondary bond market.
First, let's discuss what bond loans are. Bonds are long-term, low-risk investment products. Corporations can issue private bonds, but Treasury bonds issued by the federal government are much more well-known. When you buy a bond, you give the government a set amount of money per bond. The bond then accrues two types of interest: fixed interest and inflation interest.
The fixed interest on a savings bond follows the sam
e model as the fixed interest on a mortgage loan. Every year on May 1 and November 1, the U.S. Treasury announces a fixed rate for new loans. This is also known as the bond's coupon rate.
For example, for bonds issued between November 1, 2023, and April 30, 2024, the bond rate is 5.27%.
You’ll earn that percentage of interest on the loan if you buy one before the next interest rate announcement. It's important to note that although the bond coupon rate is fixed year-to-year by the U.S. Treasury, the price of a bond sold in secondary markets can fluctuate.
Your bond also accumulates additional interest to keep up with inflation rates. Once your bond reaches the end of its term, you get your original money back plus whatever the bond gained in interest. You can also buy and sell bonds on the secondary market, like stocks.
The connection between mortgages and bonds is rooted in the competition for investments. Both bonds and mortgage-backed securities appeal to similar investors seeking stable returns with a level of security.
Typically, as bond interest rates change, so do mortgage rates, although mortgage rates are generally slightly higher to account for the increased risk in mortgage lending.
For instance, bonds issued from November 2023 to April 2024 have a composite rate of 5.27%, while those from May 2023 to October 2023 had a rate of 4.86%.
Consequently, mortgage rates rose alongside bond rates, but at a somewhat elevated level. For example, in May 2023, the rate for a 30-year fixed-rate mortgage was 7.17%, rising to 7.22% by November 2023.
Keep in mind that even though the current bond coupon rate is fixed, bond prices can fluctuate based on market sentiments and economic conditions.
To illustrate this relationship further, consider buying a Treasury bond for $1,000 with a 2% annual fixed interest rate. Once purchased, you're locked into that 2% rate until maturity. Now, imagine a year later, interest rates have increased, and a $1,000 bond can now yield a 3% annual return.
In that same year, if you need cash and decide to sell your bond, you likely won't get the full $1,000. Other investors know they can achieve a 3% return by investing $1,000 in a new Treasury bond. Thus, the price of your bond will drop to what investors are willing to pay.
For example, an investor might offer you $900 for your bond. Essentially, your bond's price is lower because current market rates are higher. Although you can still redeem your bond for $1,000 upon maturity, its present liquid value is less than $1,000.
Conversely, if the Treasury decreases bond rates, the opposite occurs. Suppose the Treasury announces that $1,000 bonds will now have a 1% interest rate. Investors realize they benefit more from purchasing your bond since it yields more interest. With increased demand for your bond, you can sell it to the highest bidder.
The bond you bought for $1,000 might now be valued at $1,100 by an investor who wants to hold it until maturity. The investor purchasing your bond for $1,100 will still receive $1,000 when selling it. However, at present, it's worth $1,100 because interest rates are declining, and an investor wants to secure their funds at a higher rate.
These shifts have a ripple effect on mortgage rates. Mortgage lenders set their rates slightly above bond yields to attract risk-averse real estate investors while offering them security through property collateral.
This means that when bond rates rise due to falling prices, mortgage rates generally increase to follow the trend. Conversely, robust bond markets with high prices and low yields lead to decreased mortgage rates.
Not all mortgage types are impacted by Treasury bond rates. Bond prices primarily affect fixed-rate mortgages because lenders link fixed interest rates to bond rates.
Now, let's consider an adjustable-rate mortgage.
In this scenario, the Federal Reserve's latest interest rate decision is crucial. If the Federal Reserve (the Fed) decides to lower the interest rates on federal loans available to banks, your mortgage loan costs will decrease. Conversely, if federal rates increase, your costs will rise.
While you can't control the bond market's movements, you can choose which mortgage lender to work with. It's wise to compare different lenders and explore all available interest rate options before deciding on a company.
Opt for a lender with a strong reputation and competitive rates. Ultimately, the quality of your lender's customer service and policies will have a more significant impact on your loan experience than the fluctuations in the bond market.
The bond market and mortgage rates share an inverse relationship, primarily because mortgage lenders vie with Treasury bonds in the secondary market. When bond prices rise, mortgage rates tend to fall, and conversely, when bond prices drop, mortgage rates generally climb.
Consider this scenario: Suppose you want to sell a $1,000 Treasury bond with a 4% interest rate, but this time you wait two years to sell it, and Treasury interest rates have decreased to 3%. Since your bond offers a higher return compared to the current Treasury bonds, it becomes more attractive, allowing you to sell it for $1,100.
However, this increased price might deter some investors, prompting them to seek alternative investments in the secondary market, such as mortgage-backed securities (MBS). Priced out of your bond offer, these investors still seek better returns than what the Treasury provides, leading them to accept lower interest rates on MBS products. This prompts organizations like government-sponsored enterprises (GSEs) and banks dealing in MBS to package mortgages with reduced rates.
It's important to understand that not all mortgage rates are influenced by the bond market. Bond prices primarily impact fixed-rate mortgages. Adjustable-rate mortgages (ARMs), on the other hand, are more directly affected by the Federal Reserve's decisions. With an ARM, your monthly interest rate will be influenced by the short-term federal funds rate target set by the Federal Reserve.
To better understand this dynamic, consider the following scenario. Suppose you purchase a Treasury bond for $1,000 with a 2% annual fixed interest rate. Once acquired, you're committed to this 2% rate until the bond reaches maturity. Now, imagine a year has passed and interest rates have risen. A $1,000 bond investment now offers a 3% annual interest rate.
During that same year, you find yourself in need of cash and decide to sell your bond. It's unlikely you'll be able to sell it for the full $1,000. Other investors are aware they can earn 3% by investing their $1,000 in a new Treasury bond. Consequently, the price of your bond will decrease to whatever amount other investors are willing to pay for it.
For instance, an investor might offer you $900 in cash for your bond. Essentially, your bond's price has dropped because current market rates are higher. Although you can still redeem your bond for $1,000 at maturity, its current liquid value is less than $1,000.
If the Treasury reduces bond rates, the opposite situation occurs. Suppose the Treasury announces that $1,000 bonds will now carry a 1% interest rate. Investors realize they would benefit more from purchasing your bond, as it generates more interest. With increased competition for your bond, you can sell it to the highest bidder.
The bond you initially bought for $1,000 might now be valued at $1,100 by an investor who wishes to hold onto it until maturity. The investor who purchases your bond for $1,100 will still receive $1,000 when they sell it. However, at present, it's valued at $1,100 because interest rates are declining, and an investor wants to secure their funds at a higher rate.
Fortunately, the inflation numbers have been relatively tame. But those numbers are entirely overshadowed by the daily, or hourly, tariff announcements coming from Washington DC. For example, last Friday, another monthly report on consumer sentiment came in substantially lower than expected. The expectation for inflation jumped from 5% in March to 6.7% in April, the highest level since1981. It was the second lowest consumer sentiment on record since 1951! One would think that rates would move lower since it is an indication that our economy is not strong. Yet the bond market is more focused on the trade war the United States is waging against other nations.
Unfortunately, all of this comes right in the heart of the all-important spring housing market. Orion's brokers know that for most consumers, a home is their single largest investment and those “on the fence” about buying or refinancing now have not been given any comfort about interest rates or the economy in general. When there is this much uncertainty, people tend to hunker down until there is more clarity. Buying a home fits into this category.
But Fannie Mae now expects mortgage rates to taper down to 6.3 percent this year and 6.2percent in 2026. Mark Palim, Chief Economist at Fannie Mae, explains the underlying economic factors that shifted mortgage rate projections. “We expect the recent pullback in mortgage rates will provide a small boost to home sales this year,” Palim said. “While our latest forecast calls for a period of modestly slower economic growth, historically, interest rates have been the most important driver of home sales."
Many homebuyers have been waiting for housing inventory to rise and mortgage rates to fall before making the commitment to buy a home. This positive update could bring much-needed optimism and confidence to the housing market.
Orion's management reminds our broker clients that the bond markets and interest rates change every day. But what doesn't change is our reputation and service levels. So regardless of what is happening in Washington DC or with interest rates, Orion and our AEs continue to offer superior products at competitive rates, and in the long run that will help our clients more than predicting interest rates.
Please complete the form found below so we can stay in touch.
Fields Market with * are REQUIRED. All other fields are optional.