Bond Market & Mortgages

Yields on 10-year and 30-year Treasury securities are typically used to set long-term mortgage rates. Loans with short initial terms (1-, 3-, and 5- year ARMs, e.g.) are pegged to shorter-term securities. So when bond yields drop, typically, conventional mortgage rates fall as well. Conversely, when yields rise, so do mortgage rates.
Why? If a lender chooses to sell your mortgage loan to an investor, the lender will likely use Treasury yields as a benchmark for value.

Don't be confused by bond market terminology however, they often confuse people. When you hear or see bond prices displayed, make sure you understand that bonds have both a 'price' and a 'yield', and they move opposite of each other. So, when CNNfn says "the bond market rallied today" or that 'bonds closed up 5/32nds today", that means that the price of the bonds went up, so the yield went down. A decrease in the yield is good news for mortgage rates.

If you don't understand how prices can go up if the yield is falling, you are not alone. The concept is actually pretty simple. Let's say a 10-year bond, with a $1,000 face value is sold with a coupon rate or yield of 5%. If a year later the current interest rate environment is 5%, then the bond will sell for $1,000 on the secondary market (where one bond owner sells to another bond owner). What if the current rates rise to 6%? In that case, no one will want to buy a $1,000 bond yielding 5% when they can spend the same $1,000 to buy a $1,000 bond yielding 6%. So, in order to sell the 5% bond at a current market yield, bond buyers will only be willing to buy the 5% bond if they can buy it at a discount. If that same bond were discounted to about $910, then over the remaining 9 years it will pay a 5% coupon, PLUS it will be worth $1,000 in 9 years, which will mean that is will effectively appreciate at about 1% a year, yielding a 6% annualized return. So, when interest rates rose, the price of the bond had to fall to yield the greater return demanded by investors. Conversely, if interest rates fall, the price of the bond will rise to reduce the return on the bond.

The bond market refers to people and entities involved in buying and selling of bonds and the quantity and prices of those transactions over time. Participants in the market trade bonds issued by corporations and various government bodies.

Because of the relationship between bond prices and interest rates, references to the "bond market" are often used to indicate changes in interest rates or the shape of the yield curve. Other names for the bond market are the credit market and the debt market.

The daily buying and selling of T-bonds. Lenders pay close attention to this market, because as the yields of bonds go up and down, fixed rate mortgages do close to the same thing. The same variables that affect the Treasury Bond market also affect mortgage rates at the same time.

Unlike the Prime Rate these bonds are directly correlated with current mortgage interest rates.

One way to track the market is to look at a 60 or 90 day moving average of the 10 year US bonds. Since mortgage rates are based on bonds, the moving average will give you the best view of where rates are trending.

Mortgages ultimately are packaged together as CMO's or Collateralized Mortgage Obligations and sold on the secondary market as bonds. This also explains why doucumentation for loans are required to be uniform.

At certain times, such as in the bond market of early 2007, the yield curve on the 10 year note is inverted, which creates a variety of interesting effects. For example, in many cases of yield curve inversion, the average rate of a 30 year fixed mortgage is actually marginally lower than that of many short term adjustable rate mortgages.

» DISCLAIMER: The information contained in this article on 'Bond Market & Mortgages' is a collection of contributions by licensed mortgage professionals and is not the opinion of Broker Outpost LLC. Always consult a licensed professional before applying for a mortgage.