Whether you’re looking to buy a home or even refinance your current mortgage, you may have heard that mortgage rates and treasury bond yields are closely related.
But what exactly does that mean, and how does it impact you? I’ll explain…
First, let’s define some terms. A mortgage rate is the interest rate that a borrower pays on their mortgage loan. This rate can vary depending on a number of factors, such as the borrower’s credit score and the size of the down payment. On the other hand, a treasury bond yield is the return that investors earn on their investment in U.S. government bonds. Treasury bonds are considered a low-risk investment because they are backed by the full faith and credit of the U.S. government.
Now, let’s look at the relationship between these two rates. Mortgage rates and treasury bond yields are both influenced by the overall interest rate environment in the economy. When the Federal Reserve (the “Fed”) sets the federal funds rate (the interest rate at which banks lend to each other overnight), it affects the entire interest rate market. This includes both mortgage rates and treasury bond yields.
When investors buy treasury bonds, they are essentially investing in the U.S. government debt. The price of these bonds is determined by the market demand for them. As demand for treasury bonds increases (typically during volatile times), their price goes up and their yields go down. Prices and yields have an inverse relationship: when one goes up, the other goes down.
This means that when times get volatile and investors flock to safe investments like U.S. government bonds, then the price of those bonds go up, their yields go down AND mortgage rates typically follow that same downward trend.
This decrease in treasury bond yields affects mortgage rates because many mortgage lenders use treasury yields as a benchmark to set their own interest rates. Specifically, mortgage lenders typically use the 10-year treasury bond as a benchmark for the interest rate they offer on a 30-year fixed-rate mortgage. This is because the 10-year treasury bond is considered a good indicator of the long-term interest rate environment.
When the yield on treasury bonds goes down, mortgage lenders can afford to lower their own interest rates because their cost of borrowing (which is tied to treasury yields) has decreased. This can make mortgages more affordable for borrowers, which can lead to an increase in demand for homes and an overall boost to the housing market.
Conversely, when the yield on treasury bonds goes up, mortgage rates also tend to increase. Higher mortgage rates can make homes less affordable, which can lead to a decrease in demand for homes and a cooling off of the housing market. This is exactly what happened in the second half of 2022 when interest rates went from in the 3’s to the 6’s.
There’s more to it…
It’s worth noting that the relationship between mortgage rates and treasury bond yields is not always straightforward. Other factors, such as inflation and economic growth, can also influence both mortgage rates and treasury bond yields. Additionally, mortgage lenders don’t always follow treasury yields precisely when setting their own interest rates, they have flexibility to set their own rates. Still, treasury yields are an essential benchmark for mortgage rates, and changes in yields can have a significant impact on the housing market.
Keep in mind that mortgage rates can vary widely between lenders. Shopping around for the best mortgage rate can save you thousands of dollars over the life of your loan, so it’s essential to compare rates from multiple reputable lenders.
Final Thought
When investors buy treasury bonds (which typically happens during volatility), the increased demand for these bonds leads to a higher price and therefore a decrease in their yield. This decrease in treasury bond yields can then lead to lower mortgage rates for you as a home buyer as lenders use these yields as a benchmark to set their own interest rates. By working with a lender who keeps an eye on treasury yields and shopping around for the best mortgage rate, you can save money and make the most of the current interest rate environment.