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Interest Rates
Mortgage rates tend to move in the same direction
as interest rates. Mortgage interest rates, in most cases,
are tied to the U.S. treasuries 10 year bond yield. However,
actual mortgage rates are also based on supply and demand
for mortgages. There
is usually an almost fixed spread between those with the
best credit ratings mortgage rates and treasury rates. However,
this is not always the case. External market forces can occasionally
keep mortgage interest rates and treasury rates from moving
in lock-step.
Bonds Rates
There is an inverse relationship between Bond prices and
bond rates. This can be confusing. When interest rates move
up, bond prices move down and vice versa. This is because
bonds usually have a fixed price at maturity - typically
$1000. The bond will start off being sold for the face value,
$1000 and at a set interest rate. If interest rates now go
down, then this bond will go up in price so that these bonds
will remain fairly priced compared with current bond offerings.
Obviously the longer before the bond matures for face value,
$1000, the greater the price premium will be to enjoy that
higher than current yield for the rest of the bond's term.
The inverse also applies. If interest rates move up, the
bond seller will have to reduce his price to offer a similar
yield to current bond offerings.
The overall economy
If the Federal Reserve raises its prime lending rate to curb inflation, banks
also raise their lending rates. Rates also tend to rise if there is more
demand for home loans, which can slow the housing market and make more homes
available. Higher rates can spur borrowers to crowd the home and loan markets.
When the economy is slow, consumers and businesses don't borrow as much,
leading to lower interest rates. When the economy is booming, demand for
borrowing increases, leading to higher interest rates.
Bond market
Lenders use detailed formulas to determine interest rates based on the performance
of the U.S. bond market.
Competition
The cost of a home loan is sensitive to competition. It pays to shop around
for a lender. Let those you contact know you are comparing them with competitors--you
may get more favorable loan terms.
Most bonds are traded on the open market before they reach
maturity. This causes bond prices to fluctuate. This
means that it's unlikely bonds will sell for "par," or
100% of its face value. As you already know, a bond's
periodic coupon and its ultimate payout never change once
the bond is issued. So when a bond sells on the secondary
market, any change in the price of the actual bond, will
change the bonds yield.
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