The Mortgage Note

 Wednesday, March 19, 2008 7:57:35 AM

Mortgage rates, like I said yesterday, are not directly affected by the activity of "the Fed"; they are a confusing function of stock market activity.  This is how I have come to understand what determines rates:

Stock exchanges sell both stocks and bonds; bonds include a variety of items, a significant portion of them being mortgage-backed securities.  The attraction to buying MBS's is the rate of return, which is determined by the interest rate and type of loan in the bundle(s) offered for sale.  The sales activity is the inverse of stock sales activity, because investors are looking at profits and ROI.  When stocks are strong, and activity is heavy on the trading, bond sales are low.  In order to induce investors away from the purchase of stocks and/or options, lenders will raise interest rates on the mortgages represented by the bonds offered.  If stock sales are high, the mortgage rates will increase due to decreased sales in MBS's. 

Conversely, when the stock prices begin to fall more people seek the safety of the guaranteed returns provided by MBS's.  Since sales are heavier, lenders can lower their rates and still be able to sell the bundled mortgages on the open market.  This is good news for the borrowers, because the rates they pay on money borrowed are less.  Rates change several times daily, based on the volatility of the market:  some days may have one change, while others have five or more.  (Often, changes occur after banking hours EST due to West Coast activity or activity in foreign markets.  In today's global economy, volatility in even Australia or New Zealand can cause massive change in mortgage rates in the United States.)

Coming soon:  How the Changes Can Vary Based on Type of Loan in the Bundle