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Why is it a good idea to track the bond market if I'm thinking about buying a home or refinancing my mortgage?
Banks and other lenders use the yield on the government's 10-year Treasury note as the benchmark for setting mortgage interest rates. There's always a spread between the 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. For example, say the yield on the 10-year Treasury is 3.4 percent; then mortgage rates will be around 5.4 percent. 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. 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.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. 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. How does all this tie into the all the hype surrounding whether or not the Federal Reserve and Chairman Alan Greenspan 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. So keep track of the 10-year Treasury yield if you're shopping around for a good mortgage rate. And when the yield is super low -- lately hovering around 3.35 percent, a low not seen since 1958 -- you can be certain it's a good time to lock in that mortgage rate. |