How bonds affect mortgage rates

Your mortgage rate is determined in part by bond markets. Yields on bonds – especially 10-year Treasury bonds – and mortgage rates move together, while bond prices have an inverse relationship with mortgage rates. When Treasury yields increase, so do mortgage rates. When yields fall, mortgage rates follow. Learn more about how bonds and mortgage rates are related and how bonds help determine mortgage rates.

Key takeaways:

• Ten-year Treasury yields and mortgage rates are influenced by similar factors, meaning that they tend to rise and fall in tandem.
• Investors are more likely to buy bonds and mortgage-backed securities during periods of economic uncertainty because bonds offer reliable returns.
• When yields on MBSs increase, mortgage rates decrease, and vice versa.

How bonds work

Bonds are long-term, low-risk loans. Municipal governments and school districts often sell bonds to raise money for capital improvements and construction. Private companies sell bonds to raise money without bringing in outside investors. When you buy a bond, you're essentially lending money to the company or government that issues it.

Bond buyers receive fixed interest payments known as coupons, usually twice a year. When the loan matures, the principal is returned to the investor.

Once bonds are issued, they can be sold on secondary markets. When demand for bonds increases, the price also increases. This reduces the yield or return on those bonds because people are paying more for a fixed interest payment. When demand is lower, bond prices fall, which increases the yield because you're paying less for the fixed return.

One of the safest and most reliable investments available to the public is the 10-year U.S. Treasury bond, which is backed by the federal government.

How do bond rates affect mortgage rates?

The bond market and mortgage rates have a direct relationship. When bond yields increase, so do mortgage interest rates. When yields fall, mortgage interest rates follow. This is because bond prices and prices for mortgage-backed securities (MBS) tend to change in tandem.

An MBS is a pool of mortgages, often with similar characteristics. Ownership shares in these pools are sold on secondary markets, with investors' returns coming from the payments homeowners make on their mortgage principal and interest. The return on an MBS often is greater than that on corporate investments, but it can vary and may carry risk. For example, late mortgage payments or defaults can reduce the amounts paid to MBS investors.

When investors are looking for safe investments, they often buy bonds and MBSs because they're relatively low risk. This increases demand and prices for both types of investment. Higher prices reduce the yields on MBSs, so lenders increase the mortgage rates they charge customers to compensate.

Similarly, when MBS prices fall, the yields increase and lenders have more money available and try to attract customers with lower mortgage rates.

Which mortgage rates are affected by bonds?

Regardless of whether you have a fixed-rate or adjustable-rate mortgage (ARM), your rates are affected by the bond market.

• With a fixed-rate mortgage, expect to pay a rate that's roughly 2% higher than the long-term Treasury yield curve. For a 30-year fixed loan, the bond of choice for comparison by investors is typically the 10-year U.S. Treasury.
• The introductory fixed rate on an ARM is determined the same way. Once that rate expires, your rate will adjust once or twice a year based on market rates. Treasury bond yields serve as the basis for the Secured Overnight Financing Rate and the constant maturity Treasury indexes, which, in turn, affect the rates for conventional, FHA, and VA ARMs.

The bottom line: Cheaper bonds often mean higher mortgage rates

Mortgage rates are influenced by bond yields because bonds attract investors seeking stable returns. Economic instability or uncertainty can push investors away from the stock market, and bonds act as a safe, reliable alternative. As bond yields decrease, mortgage rates do the same, and vice versa. Understanding the relationship between the two can help you understand how mortgage rates are set.

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