Here at Market Alert, we pride ourselves on being at the top of the mortgage rate forecast game. Proprietary algorithms allow us to predict market and mortgage rate trends without having to rely solely on past data and information sets us apart from the competition. The fact that we have been in the game for nearly 20 years also lends us a certain depth of knowledge, just waiting to be tapped by entrepreneurial spirits. With that in mind, we’d like to offer a bit of insight into how bonds can impact mortgage interest rates.
Bonds and mortgage interest rates are similar in that they both represent investments. Both bonds and mortgages (things like mortgage-backed securities) are attractive options for investors because they provide a fairly stable return and are relatively low risk in comparison to other types of investments.
To get a better idea of how bonds and MBS are different, it’s necessary to define both separately. Bonds represent ownership of a stream of future payments, typically interest payments and the return of the principal (the original purchase price of the bond). A mortgage-backed security is an asset-backed security secured by a collection of similar mortgages. These collections can be bought and sold in smaller pieces or bundled together with other similar MBS.
Why These Investments Are “Low-Risk”
To understand how bonds affect mortgage interest rates, we need to take a closer look at how they work. Bonds, as outlined above, represent ownership of future profit. Investing in bonds is typically considered a low-risk endeavor, making them a popular choice. Why are they considered low risk? Typically bonds are sold to large organizations such as companies, cities and municipalities, and countries. Large organizations such as these are generally more reliable than individual borrowers because they are far more likely to pay back the loan. Bonds are also considered low risk because there are bond agencies that examine and report on the risk factors involved in the purchase and sale of specific bonds. The last factor that contributes to the relative “safety” of bonds is that they can be resold on the open market, which means that investors aren’t tied to them for their lifetime.
Investors are always on the lookout for predictable outcomes based on low risk. However, some are more willing to take bigger risks if it means receiving higher returns. There are a number of bonds that suit each type of investor.
Mortgages and mortgage-backed securities tend to be higher risk investments than most bonds because of their duration. Mortgage loans are long-term, typically set out over the course of 15 to 30 years. This does, however, put them in direct competition with Treasury bonds which usually have a duration lasting from 10 to 30 years as well. Because of the similarity between the two, banks tend to take their cue from the Federal government when it comes to setting interest rates.
Stay posted until next time when we will look at the relationship between Treasury bonds and mortgage interest rates and how one directly influences the other. In the meantime, stay ahead of the curve with the TrueCast™ MBS Forecast system from Market Alert. Get started today with a free one-week trial!