There are certain misconceptions in the minds of people related to factors that determine mortgage rates. Let us try to explore these in details to find real truth behind these myths.

Mortgage rates moves with Federal Reserve’s  Fund Rate

Many consumers are misguided about the different factors in the economy that affects mortgage rates. There is a common misconception among borrowers and also some members of the media that the Federal Funds Rate set by the Federal Reserve is related to mortgage rates, but when the Fed cuts the Fed Funds Rate and mortgage rates are not affected accordingly then this concept of people proves to be wrong.

The reason behind this is that mortgage rates are determined by Mortgage Backed Securities (MBS) and the current coupons they are trading at.MBS are traded every business day just like stocks and other bonds. As MBS’s demand increases, its price goes up and its yield goes down and thus resulting in lower mortgage rates.

In a more simple way we can say that mortgage rates are anything that increases investor demand to buy mortgages resulting in lower mortgage rates. For example when investor pulls out their money from stocks they usually try to invest in safer fixed income investments and MBS is one option they have. So when stocks decline that also increases the demand for MBS.

Another factor that could increase investor demand for mortgages is deflation.MBS and other bonds are fixed income investments so due to inflation the return on that type of investment diminishes. If there is deflation then the fixed investments remain attractive. On the other hand, if inflation is high then investments like MBS are less attractive and demand decreases which ultimately results into an increase in mortgage interest rates.

The reason that mortgage rates often increase when the Fed lowers rates is because the lower Fed rate Stimulates the economy and become a reason of higher inflation in the future which is a bad sign for mortgage bonds that is why mortgage rates usually increase when the Fed cuts their rate.

Mortgage Rates are based on the 10 year Treasury bonds

Another misconception is there in the minds of some people that mortgage rates are based on the US 10 year Treasury bond. Many times it happens that the MBS market moves within a certain spread compared to the 10year but sometimes there is a large disconnection between the MBS and 10year US treasury bonds.The problem that we are currently facing is to keep mortgage rates higher so that they could be given more traditional spreads. There are days where the yield on the 10yr will drop while the yield for MBS will increase when normally they would move in a similar path.