There are many components that make up what you pay for your home. Along with price, the interest rate on your mortgage is another important consideration.
Currently, mortgage rates sit a little lower than they did last year. The average rate on a 30-year mortgage is 6.94%.
However, there hasn't been as much budge as prospective homebuyers would like. When the Federal Reserve cut interest rates three times to end 2024, mortgage rates didn't follow suit.
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In fact, they peaked above 7%. Why? While the Federal Reserve’s decisions can influence savings accounts and short-term lending rates, mortgage rates tend to follow the 10-year Treasury yield more closely.
What's the 10-year treasury yield?
The 10-year treasury yield is the government's borrowing cost for a decade. As such, the treasury rate influences everything from corporate bonds to mortgage rates.
You can see the correlation between mortgage rates and the 10-year treasury bond in the chart below:
Why are mortgage rates tied to the 10-year treasury yield? Since mortgages last longer than shorter-term lending options tied to the federal funds rate, they require a benchmark, where the duration reflects the average mortgage.
This is why the 10-year treasury yield comes in because it lasts about as long as the average homeowner has a mortgage.
If you're in the market for a new mortgage, use the tool below from Bankrate to compare and find some of today's rates:
How does the treasury yield impact mortgage rates?
Currently, the 10-year treasury yield is 4.389%. Who determines the yield? It's investors' expectations on short-term interest rates.
When investors buy mortgage backed securities, they are pledging money for a longer term than say a one-year treasury bill since they're investing in a package of mortgage loans.
As such, there's more risk that can come with longer term investments.
It's why investors want a term premium to ensure they're making money on their investment. This premium influences the interest rate you'll pay on mortgages.
They use the following economic factors to guide their expectations:
- Monetary policies: When the Federal Reserve sets the federal funds rate, it's a benchmark for short-term rates. While it doesn't directly impact mortgage rates lenders assess, it can give investors an idea of future monetary policy, which they can use to influence investing decisions.
- Economic growth: When the economy does well, investors seek more promising opportunities like equities. Meanwhile, when there's economic uncertainty, investors look for safer investments, which treasury bonds offer.
- Inflation: When inflation becomes higher, investors seek higher interest rates. It's the reason why you see mortgage rates close to 7% currently, because there's uncertainty over how much the trade wars will impact inflation moving forward.
What's the mortgage spread?
On top of this, there's a mortgage spread. It's the difference between your mortgage rate and the 10-year treasury yield. Traditionally, it's been between 0.71 points and 1.4 points, according to the Fannie Mae.
The spread consists of two parts: The primary-secondary spread and secondary spread. The primary-secondary spread factors in mortgage origination fees, other lender costs and profits.
Meanwhile, the secondary mortgage spread is the difference between the mortage back security (MBS), which investors purchase, and the 10-year treasury rate.
The secondary spread covers some risks investors might face.
To illustrate, an increased risk of prepayment can cause the spread to increase since investors won't maximize returns if the mortgage ends prematurely.
This can happen when homeowners shop around and find a lower interest rate, they might be inclined to take advantage of it through refinancing.
The bottom line
Mortgage interest rates continue to be higher because the 10-year treasury yield is high.
As such, shopping around for the best mortgage rate is one of the more effective ways to lower total loan cost. Doing so ensures you don't have to overpay on what could be the biggest investment you'll make.
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