By Stacy Williams

The economy can affect mortgage interest rates through both influencing credit availability and mortgage applications, but the results are somewhat uncertain, meaning that the state of the economy does not have a perfect correlation, positive or negative, relative to the levels of mortgage interest rates. Financial resources can expand and shrink as the economy evolves, but competing uses for money and credit can further change resource allocations among sectors inside the economy. On the other front, certain income levels as reflected by different economic conditions can either hinder or support mortgage applications, but housing prices can actually neutralize such effects.

Mortgage Interest Rates, Credit Availability and the Economy

In general, credit expands or shrinks when the economy starts to grow or begins to fall. And that is particularly true for mortgage credit availability. A recovering economy attracts more capital back to mortgage lending, one of the most prominent debt markets, potentially lowering mortgage interest rates. However, as the economy further expands, investors may start looking elsewhere for higher returns, creating money competition for mortgage borrowers and that may cause mortgage interest rates to rise. On the other hand, a falling economy depletes capital resources for all segments of the economy, including mortgage lending, which is then likely to see rising mortgage interest rates. But as we all witnessed recently, to save an economy from falling further, the government would step in to provide liquidity support, especially to the housing market, a big chunk of the economy, in order to keep mortgage interest rates low.

Mortgage applications are for the most part tied to household incomes, which are affected by the state of the economy. When the economy is booming and household incomes are growing, more people can afford a mortgage. As a result, increasing mortgage demand can potentially drive up mortgage interest rates. But if the housing market is over heated, high housing prices can discourage some home buyers, reducing mortgage applications and potentially pulling down mortgage interest rates. On the other hand, when the economy is in recession and unemployment is on the rise, few people think about buying a house, reducing mortgage demand and allowing mortgage rates to drop. But then as the housing market continues to fall, at some point. low housing prices can bring buyers back, especially real estate investors, and thus prop up mortgage interest rates.