How Does a 10 Year Bond Affect Mortgage Rates?

The current rate for new 30-year fixed-rate mortgages tends to run parallel with the current rate for the 10-year Treasury bond. Mortgage lenders watch the rate for the 10-year Treasury to indicate any changes in the rate they are charging for new mortgage loans. Mortgage securitization puts the rate for new mortgages in direct competition with the rates on Treasury securities.

Securitization

• The majority of new mortgages are collected into pools of mortgages with similar rates and maturities and the pool is divided into marketable securities called mortgage-backed securities--MBS. The mortgages in the MBS pools usually have some form of U.S. government guarantee from Ginnie Mae, Fannie Mae or Freddie Mac. The result is that MBS securities are government-guaranteed investments that compete directly with the debt securities issued by the U.S. Treasury.

Time Frame

• Although most mortgages have 30-year terms, few home loans are paid for the full term. The average life of a MBS pool is seven to eight years, and will fluctuate with how fast the homeowners in the pool pay off or refinance their home loans. The average mortgage pool maturity slots in between the five-year and 10-year Treasury bonds. The 10-year is more widely followed and has become the unofficial benchmark for 30-year mortgage rates.

Effects

• The competition between Treasury securities and government-backed mortgage-backed securities results in the rate for mortgages to be affected by rates in the Treasury market. If Treasury rates increase, mortgage lenders will increase the rate they charge for loans because they know they can sell the loans into a pool at a higher rate. When Treasury rates fall, mortgage rates will decline to attract more homeowners to buy homes or refinance.

History

• The historical spread between the 10-year Treasury and the current 30-year mortgage rate has been approximately 1.7 percent. During the financial crisis of the second half of 2008 into early 2009, the average mortgage rate climbed to over 2 percent higher than the Treasury and eventually 3 percent higher than the Treasury rate before recovering to a more normal spread. There is no rule that requires mortgage rates to have a certain margin over Treasury, and economic conditions may change the relationship.

Potential

• Someone looking for a new home loan to purchase or refinance can watch the rate of the 10-year Treasury to get an indication of the direction for mortgage rates. Bankrate provides a range of information on interest rates (see Resources). In early November 2010, the 10-year constant maturity Treasury was at 2.54 percent, and the average 30-year mortgage rate was 4.35 percent. At that point in time, the spread between the rates was 1.8 percent, very close to the historic average.