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How does the stock market affect mortgage rates?

Posted by  on May 17, 2012
 

Mortgage interest rates fluctuate a great deal. In fact, the best mortgage rates are sometimes good for only a few hours. Why do they move so much? Because they are driven by the same things that cause stock prices to change from one minute to the next.

Stocks and bonds move in opposite directions

One thing that pressures equity prices down is data that indicates the economy is worsening. For example, when unemployment increases, stock prices tend to move lower because there is likely to be less demand for products and services, and many companies expect earnings to drop as a result. In addition, negative economic reports make investors nervous and they tend to move away from riskier investments like stocks.

When stocks are out of favor, investors move to safer investments. Bonds deliver fixed returns. Similar to bonds are mortgage-backed securities (MBS). They are created when a company like Fannie Mae buys mortgages from lenders, and use the monthly installments to pay investors. MBS tend to move the same way bonds do.

Added demand for bonds means prices increase. That extra demand causes interest rates to drop. Because investors are nervous about the economy, they are willing to accept lower returns in the form of interest in exchange for having a safer investment.

Mortgage rates increase with economic improvement

When investors feel positive about the economy, it takes a higher rate to induce them to buy bonds. An upward-moving stock market causes them to happily sell bonds to jump back into equities. Fears of inflation also crop up in this type of economy, and bond investors start demanding higher interest rates to offset higher costs expected in the near future.

The biggest swings in mortgage rates are caused by unexpected events. For example, when economists expect unemployment to increase, and it decreases instead, mortgage rates can drop quickly.

World events can have a similar impact. When Greece's debt crisis hit the news in late 2009, and worsened in 2010, other nations panicked over its possible spread to their treasuries. As a result, mortgage rates decreased because uncertain investors ran for the safety of bonds and MBS. This phenomenon is called "flight to quality" and can swiftly change mortgage rates.

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