If you’ve gone through the process of becoming a homeowner—or if you’re going through it right now—you might have concerns about how difficult it is to lock down a rate on your mortgage until the day you finally close. While it’s unlikely that mortgage rates will change drastically day to day, compound interest adds up over time, so even changes in small fractions of a percent can save you—or cost you—thousands of dollars over the life of your loan. But why is this? Why do mortgage rates change so often?
In this article, we’ll look at the many (and often complex) factors that drive mortgage rate changes, as well as some different things that people might mean when they ask, “Why do mortgage rates change?”
Fixed-Rate vs. Adjustable-Rate Mortgages
One thing that people might be referring to when it comes to the subject of mortgage rates changing is comparing fixed-rate to adjustable-rate mortgages (ARMs), sometimes called variable-rate mortgages.
The difference between these options is in the name. Fixed-rate mortgages have an interest rate that’s locked in the moment you sign. It’ll be the same from the day you start paying until the day you send the final check and pop open the bubbly. That said, this could be affected by changes you make, such as refinancing or second mortgages, but that’s a whole different can of mortgage worms that we won’t have time to cover in this article.
Adjustable-rate mortgages, on the other hand, can fluctuate up and down. This isn’t just because your lending institution decides they like lowering or raising the price, however. ARMs are usually pegged to a fixed coefficient, such as the Federal Prime Rate or the Secured Overnight Financing Rate. This is why these mortgage rates change.
This means that your rate can go down—which feels great! But it also means your rate can go up, which can feel crummy. There’s always some level of inherent risk in an ARM due to this.
Why Do Mortgage Rates Change So Often?
The fluctuations of an ARM aren’t what everyone is wondering about when they ask why mortgage rates change so often. They want to know about the day-to-day differences between rates—fixed or variable. Why are today’s rates different from yesterday’s?
To know why mortgage rates change, you have to know how they change. Or, in other words: What causes mortgage rates to change? Are the back rooms at your local lending institution filled with mortgage rate gnomes that consult arcane crystal balls? Does your banker close their eyes and toss a dart at a chart?
The truth isn’t nearly as fun, and it’s a lot more complicated. In truth, there are so many factors that go into determining interest rates that to list all of them in one blog post would take way too long. So let’s talk about the major ones.
The Federal Reserve’s Interest Rates
If you follow the news, you’ve probably seen quite a lot of speculation and discussion over the interest rate hikes made by the Federal Reserve, or The Fed. When The Fed is combating inflation, many expect that mortgage rates will also increase. So you would be well within your rights to interpret from this that the Federal Reserve’s interest rate is what determines your mortgage rate—but you would be incorrect.
While it’s true that The Fed’s interest and lending rates, including those for mortgages, are tightly correlated, they are, in fact, independent from one another. The Federal Reserve’s interest rates don’t govern the terms under which a consumer loans money from a bank or credit union. Instead, these are the rates at which banks and credit unions can loan money from Uncle Sam.
Think of this as basic economics—the more expensive something is to produce, the higher price you charge for it. If the money the lending institution loans you costs it more to loan because the Federal Reserve has raised rates, then they’ll charge you higher rates too.
Mortgage-Backed Securities
Mortgages are deeply linked to the secondhand mortgage bond market, a common vehicle for investments. To make this (very) complicated chain of events (very) simple, it goes like this: Rather than holding on to your mortgage for the full 10 to 30 years (or however long the term is), your lending institution will often sell it to investors, who pack it in with other mortgages to create mortgage-backed securities, a popular investing vehicle.
The bond market is seen as being less volatile than the stock market, for good or for ill—you can’t get rich as quickly, but you’re less likely to go bust. Therefore, there will be more demand for these when the stock market is struggling. Since investors are going to want higher rates, competition drives mortgage interest rates down.
Economy
There are many factors that go into why interest rates change, but at the end of the day, basic economic principles apply here.
As we see with the Federal Reserve’s rates, when something is more expensive to produce, the price (i.e., the rates) goes up. Similarly, supply and demand is a major factor. There are only so many homes in the USA, after all. When the economy is good and many people are looking to buy homes, rates will go up.
This is what happened in 2021 and 2022—people moved in with their loved ones during the early pandemic crisis, when regulations meant the construction of new homes stopped. After things eased up a little bit, people had pockets full of cash, and there were many fewer homes—so home prices, and consequently interest rates, skyrocketed. But were the economy to take a downturn and fewer people seek homes, rates might instead plummet.
Inflation
The other big factor is inflation. It has often been said that inflation is the debtor’s best friend, and it’s not hard to see why. When you take out a loan, other than the interest, the amount you need to pay back is fixed. The dollar’s value decreasing—and the supply of it increasing—would therefore mean your “real money” cost is much lower.
For instance, say you have a $100,000 mortgage. If inflation jumps 100 percent (and, to be clear, this would be a catastrophically high rate of hyperinflation, which is not going to happen—it just makes for easy demonstration), and your wages increase accordingly, your mortgage would now take half the time to pay off.
Lending institutions obviously don’t want that to happen. So, when inflation is high, they raise rates accordingly—and when inflation is low, they lower them.
These are just some of the factors that explain why mortgage rates change. If you want a fair interest rate, no matter the circumstances, contact the home loan experts at Solarity Credit Union in Washington State to explore your options.