Why Do Mortgage Rates Increase?

The economy’s growth varies on inside and outside factors. When there is a low unemployment rate, there is a great indicator that the economy is producing and moving toward growth. But the economy can also be influenced to shrink. Wars or natural disasters (like COVID-19) can hamper the growth rate and potentially shrink the economy. Growth is very sensitive and changes often. When the economy is on a growth path, the demand for money increases and interest rates are pushed upward. The opposite is true when economic growth slows or stops.

When there is economic growth, often inflation also occurs. Inflation will increase the price of goods and deteriorates spending power. Inflation can slow growth in the economy. The implication for future homeowners is that inflation pushes mortgage rates higher making the home buying procedure more expensive.

Economic activity is measured nationally to determine the appropriate interest rate. The Federal Reserve Board, which is the central banking authority in the United States, measures economic growth through 12 Federal Reserve branches across the country. Federal Reserve branches collect economic information from their respective regions and report to the Federal Reserve Board during regular meetings in Washington, D.C. The outcome of this meeting determines whether the Federal Reserve will try to increase interest rates to control growth or decrease rates to spark growth and encourage borrowing.

Although the Federal Reserve is unable to directly set interest rates, the agency can influence rates indirectly by increasing or decreasing the supply of money in the economy. By increasing the money supply, the Federal Reserve puts downward pressure on interest rates. Decreasing the money supply puts upward pressure on interest rates. Consequently, if the Federal Reserve decreases interest rates, mortgage rates come down and borrowing for a home purchase is cheaper and encourages home buying.

In addition to regular monitoring by the federal government, the financial markets establish benchmarks to understand where interest rates might be headed. The yield on the 10-year treasury bond is widely considered to be a benchmark for long-term mortgage interest rates. As a result, lenders often tie mortgage rates to the 10-year treasury bond to keep the mortgage loan profitable in the long run. Any changes in the 10-year treasury bond yield influence how mortgage rates are set for current mortgages.