How Bonds Affect Mortgage Rates

Updated: 28th Dec 2021 Written by Samantha Cathey
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There are several factors that affect national interest rates. From auto loans to mortgages, the rate you may be offered is dependent on personal factors like your credit score and the amount of debt you owe, as well as market factors such as inflation and the unemployment rate.

Another market factor influencing your mortgage rate are bonds. Read on to find out how bonds affect mortgage rates.

How Does the Bond Rate Affect Mortgage Rates?

To better understand how the bond rate affects your mortgage rate, let’s break down what a bond is first.

Bonds are a fixed-income debt security that represents a loan used to raise money from investors. Think of it as an IOU between a mortgage lender and a mortgage investor.

The lender, or issuer of the bond, could be a corporation, municipality, or government that promises to pay a specified rate of interest during the bond’s lifetime.

When you or other investors purchase a Treasury bond, you give money to the federal government in exchange for regular payments of fixed interest.

Once your bond reaches maturity, or comes due, the government pays your original investment back in addition to inflation interest.

Bonds are a low-risk investment for a few reasons:

1. Loans made by big corporations and governments are almost guaranteed to be paid off.
2. Bonds must be audited by a rating agency and are assigned a risk profile.
3. Bonds are easy to trade and can be resold on the secondary mortgage market.

Mortgages are also a low-risk investment, which is why investors are attracted to ventures in both home loans and bonds.

Mortgages do carry a higher risk than their counterpart, therefore banks maintain interest rates a few points higher than Treasury notes.

This slight increase can push investors toward home loans over a bond. So, when the interest rate on a Treasury note rises, banks follow suit with their mortgages. This is good for an investor, but not a potential homeowner.

>> More: Does the Federal Reserve Affect Mortgage Rates?

What Happens to Mortgage Rates When Bonds Go Down?

Mortgage rates and bond prices have an inverse relationship. When one goes up the other dips down, and vice versa. We’re talking about bond prices now, not bond rates. How does this work?

Let’s say you purchased a $1,000 Treasury bond with a 1% interest rate. At maturity, you’ll receive an additional $100. What if you want to sell your bond before that?

If the rates on Treasury bonds have since gone up, you’ll have to lower the price of your bond to be more inviting since investors could get a higher paying bond from the government.

Because market rates are higher, your bond is worth less. If the rates on Treasury bonds have instead decreased, your bond is now worth more.

Now back to mortgage rates which move in-step with bond rates. When bond prices drop, bond rates rise and by extension mortgage rates do, too.

Which Type of Bond Impacts Mortgage Rates the Most?

The movement of the 10-year Treasury note is widely considered the best indicator to determine the direction of national mortgage rates.

The 10-year Treasury note guides 15-year conventional loans and the 30-year Treasury bond influences 30-year loans. Conventional loans are those not backed by a government agency like the VA Loans or USDA Loans.

Bond vs. Note vs. Bill

These terms are often used interchangeably when referring to Treasury financial instruments, but they do denote different term lengths, or how long you’ll have to wait to collect your principal.

Treasury InstrumentTerm Length
Bill< 1 Year
Note2 to 10 Years
Bond10 to 30 Years

Which Mortgages Are Affected by Bonds?

It’s important to note that not all mortgages are influenced by the bond market. Only fixed-income home loans (also known as fixed-rate mortgages) feel the effects because lenders base their mortgage rates directly on what Treasury bond rates do.

Adjustable-rate mortgages are guided more so by the federal funds rate, which is the super short overnight rate banks use to lend and borrow money from one another.

Note: if you already have a fixed-rate mortgage, it’s not fluctuating with the bond market because your rate is locked in. Just the general rate offered to new mortgage applicants is influenced.

>> More: Fixed vs. Adjustable-Rate Mortgages

Bottom Line: How Bonds Affect Mortgage Rates

The following discourse is a simplified version of the relationship between bond rates and mortgage rates.

Mortgage rates are of course susceptible to general economy activity, just like bonds and other investments.

If the economic outlook is positive with stock market advances, bond and mortgages rates will probably rise, too.

While it’s never recommended to time the stock market, paying attention to the bond market can help you determine what rates may be doing on the mortgage front.

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Samantha Cathey
Samantha Cathey

Samantha Cathey is a Senior Personal Finance Writer & Product Analyst with years of financial training and industry knowledge. She is a former banker, loan officer and investment advisor before dedicating her energy to helping individuals more creatively, through her writing. Samantha studied at the University of Idaho where she majored in Journalism and Writing. Her areas of expertise are mortgages, credit cards, loans, and investing.