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In order to understand how the bond market affects mortgage rates, an individual needs to understand how bonds work. Bonds can be sold through private companies or the government.

Bonds are a debt instrument issued for a period of more than one year with the purpose of raising capital by borrowing. The Federal government, states, cities, corporations, and many other types of institutions sell bonds. Generally, a bond is a promise to repay the principal along with interest (coupons) on a specified date (maturity). Some bonds do not pay interest, but all bonds require a repayment of principal.

U.S. Treasury bonds are generally considered the safest unsecured bonds, since the possibility of the Treasury defaulting on payments is almost zero. The yield from a bond is made up of three components: coupon interest, capital gains and interest on interest (if a bond pays no coupon interest, the only yield will be capital gains). The 10-year Treasury bond is said to be a very good indicator when determining the rise and fall of mortgage rates.

So how do bonds affect mortgage rates?

If you are looking to determine when interests rates will adjust take a look at the 10-year Treasury bond. Typically, when bond rates (also known as the bond yield) go up, interest rates go up as well. And vice versa. Don’t confuse this with bond prices, which have an inverse relationship with interest rates.

So theere is no specific fixed rlationship between Treasuries bonds of any variety and fixed mortgage interest rates. Given enough data points, a relationship could be established against many different financial instruments.

Bonds and Mortgage-Backed Securities (MBS) actually compete for the same investor dollars. The difference is that Treasurys are 100% guaranteed to be repaid, but mortgages are not. With that said, mortgages securities carry much more risk. Thus mortgage rates need be priced higher to compensate for the risk factors.

Bonds and that mortgage rate relationship is not tied to each other, but they do affect one another with changing market conditions.

We at LoanSafe.org believe that a larger market influence will affect rates and it came this past March when the Federal Reserve exited the mortgage market and ceased its program of purchasing $1.25 Trillion in Mortgage-Backed Securities. If private investors do not step in to buy these MBSs then rates may rise significantly. In addition, the Fed has over a trillion in mortgages that it needs to unload in the near future.

There have been, and will be periods of time where mortgage rates rise faster than the bond, and vice versa. So just because the 10 year bond rises 20 basis points doesn’t mean mortgage-backed securities will do the same. In fact, MBS could rise 25 basis points, or just 10 points, depending on other market factors.

So to wrap it up, bonds do not necessarily relate to mortgage rates, but they do seem to rise and fall in align with them. For many mortgage analysts this is the one if the best factors used when determining when mortgage interest rates will adjust.

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