There is no benchmark rate to which 30-year mortgage rates are tied by law or by regulation. Contrary to popular opinion, the federal government does not directly control mortgage interest rates, either through the federal funds rate--the rate banks use for overnight loans--or through regulation of the mortgage-money market. There are several economic and market factors, however, that do affect rates.
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Origins of Mortgage Money
Mortgage money originates in pools of investment capital which are accessed by banks and mortgage brokers by offering mortgage-backed securities. The rates on these bonds are determined by several factors, which also affect the market for other debt instruments, which include U.S. government bonds, or Treasuries; corporate bonds; the bonds of foreign governments and corporations, and so on.
Bond Rates and the Market
Various economic indicators move bond rates, including the rate of inflation, the rate of economic growth, stock market indices, the supply and demand for bonds, and the yields on competing debts issued by the U.S. government. When the market for mortgage-backed bonds declines, the prices of the bonds fall and the yield they provide to investors rises. When the market improves, the price rises and the yield falls. The interest rate thus determined by the market for these
bonds is passed through to borrowers who want to obtain a mortgage.
Mortgage rates generally track U.S. treasury obligations, which are issued by the government to fund its operations. There are several different such instruments, with the rate on the 10-year note providing the closest correlation to 30-year mortgage rates (as these mortgages are normally paid off or refinanced in an average of 10 years after they originate). Because treasuries are considered safer investments, they carry a lower yield than the mortgage-backed securities, and therefore track less than 30-year mortgage rates.
The difference between treasuries and 30-year mortgage rates is known as the "spread" and averages about 1.7 percent under normal market conditions. The spread will widen when investors are seeking the greater security of treasuries, and mortgage-backed bonds--which are always perceived as riskier--fall in value. When conditions stabilize, the investors seeking greater yield move their money into mortgage-backed securities, their price rises and interest rates fall.
Mortgage interest rates are also affected by the housing market and the demand for home loans. When there is a high demand for mortgage money, the supply of mortgage-backed securities increases and their price tends to fall with falling demand--causing a rise in interest rates.