To understand why mortgage rates change we must first ask the more general question, “Why do interest rates change?
It is important to realize that there is not one interest rate, but many interest rates. Prime rate: The rate offered to a bank’s best customers. Treasury bill rates: Treasury bills are short-term debt instruments used by the U.S. Government to finance their debt. Commonly called T-bills they come in denominations of 3 months, 6 months and 1 year. Each treasury bill has a corresponding interest rate (i.e. 3-month T-bill rate, 1-year T-bill rate). Treasury Notes: Intermediate-term debt instruments used by the U.S. Government to finance their debt. They come in denominations of 2 years, 5 years and 10 years. Treasury Bonds: Long-debt instruments used by the U.S. Government to finance its debt. Treasury bonds come in 30-year denominations. Federal Funds Rate: Rates banks charge each other for overnight loans. Federal Discount Rate: Rate New York Fed charges to member banks. Libor: London Interbank Offered Rates. Average London Eurodollar rates. 6 month CD rate: The average rate that you g
Interest rate movements are based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do interest rates. This is because there are more buyers, so sellers (those who loan the money) can command a better price, i.e. higher rates. If the demand for credit reduces, then so do interest rates. This is because there are more sellers than buyers, so buyers can command a lower better price, i.e. lower rates. When the economy is expanding there is a higher demand for credit, so rates move higher, whereas when the economy is slowing the demand for credit decreases and so do interest rates. This leads to a fundamental concept: • Bad news (i.e. a slowing economy) is good news for interest rates (i.e. lower rates). • Good news (i.e. a growing economy) is bad news for interest rates (i.e. higher rates). A major factor driving interest rates is inflation. Higher inflation is associated with a growing economy. When the economy grows too strongly, the Federal Rese
