One of the most important factors to consider before purchasing a home is the current mortgage rate. This can greatly impact your monthly mortgage payment, and, if the rate is low, put certain homes well within your budget. Prospective homebuyers can better anticipate future mortgage rates by gaining a general understanding of treasury yields and their effect on mortgage rates. Here’s what you need to know:
What are treasury yields?
The treasury yield is a return on investment in a U.S. government debt, as represented by a percentage. It can also be thought of as the interest rate that the government pays when borrowing money for various lengths of time. Treasury yields influence a variety of economic factors, including investor earnings and interest rates for loans on real estate, cars, and businesses.
Correlation between Treasury Yields and Mortgage Rates
Treasuries are very sound investments, as they are backed by the full faith and credit of the U.S. government which ensures investors are guaranteed their coupon payment. Treasury yields and mortgage rates have a reciprocal relationship, meaning that when treasury yields rise, so too do mortgage rates.
When analyzing interest rates, investors compare the 30-year mortgage rate with 10-year treasury bills. Since these treasury bills are backed by the full faith and credit of the U.S., they are lower risk than mortgage debts. The spread between 30-year mortgages and 10-year treasury bills usually sits somewhere between 1% and 3%.
Increasing Treasury Yields
As treasury yields increase, so do mortgage interest rates. Both increase as a result of the Federal Reserve reining in the country’s economic growth. Higher rates usually discourage potential home buyers from taking on a fixed-rate mortgage. When the demand for homes drops, the economy slows down and decreases real estate resale value. The Fed can then choose to lower the interest rates to jump start the economy once again.
Conversely, decreasing treasury yields encourage a drop in mortgage interest rates. This decline inspires homebuyers to purchase their first home or upgrade to a larger property. If too many people take on mortgage loans at low rates, the Fed can choose to increase the treasury yield, prompting mortgage rates to rise and slow down the economy.
Having a basic understanding of the symbiotic relationship between treasury yields and mortgage rates helps homebuyers make financially prudent decisions. If the treasury yield has plateaued at a high point, prospective homebuyers may consider waiting to take out a mortgage until the treasury yield drops. The converse is also true.
Understanding the fluctuations of treasury yields and mortgage rates can be challenging.
By Michaela Phillips. Michaela is the Vice President of Mortgage Lending at Guaranteed Rate, Inc. Contact Michaela at 303.579.5517, e-mail email@example.com or visit michaelaphillips.com.