The mortgage interest rate available for an individual borrower is based on the borrower’s financial history and current status. When it comes to the range of rates available to all borrowers on a given day, several economic factors are involved, including conditions on the bond market, inflation and housing demand. The correlation between mortgage rates and the stock market is less direct.
Although there is no direct relationship between mortgage rates and the stock market, it can be argued that an increase in mortgage rates results in lowered levels of discretionary income and, consequently, a decrease in stock market investment. However, a variety of other factors, such as government intervention and the housing market as a whole influence this situation.
Bond Market Influence
Lenders typically don’t hold onto mortgage loans for the life of the loan. Instead, they create mortgage-backed securities by packaging groups of loans together. These securities, also known as mortgage bonds, are then traded on the bond market. Conditions on the bond market play a large role in determining mortgage rates.
When there are a lot of mortgage bonds being purchased for investment, you are more likely to get a lower mortgage interest rate. When there’s lower demand for this type of bond due to competing investing opportunities, mortgage rates rise.
Federal Reserve Intervention
The U.S. government has an interest in keeping inflation low since high levels of inflation cause a decrease in the value of the dollar on the international market. The Federal Reserve, the nation’s central bank, monitors the behavior of the bond market and will intervene to stimulate the economy by lowering the mortgage rate.
This is accomplished by buying enough mortgage bonds to lower the interest rate. If raising the interest rate seems appropriate, the Federal Reserve will sell mortgage bonds while raising the Fed Funds rate, which is the rate at which banks borrow money from the Federal Reserve for investment.
Bonds Seen as Safer
When there’s uncertainty in the economy, many investors look for safer places than the stock market to put their money. Bonds in general are seen as a safe investment, including mortgage bonds. When more investors seek the safety of mortgage bonds, the increased demand leads to a drop in interest prices.
On the other hand, when the economy is doing well and the stock market is outperforming bonds, then mortgage bonds are sold off and the mortgage interest rate rises. In this case, the stock market is not driving the mortgage rate but it does play a role in whether it goes up or down.
Housing Market Influence
The supply and demand of homes for sale also impacts mortgage rates. When there are fewer new and resale homes for sale, but the demand is high, lenders will feel obliged to raise rates. A glut of homes and not enough buyers will likewise lead to a drop in rates. Housing inventory and the number of available buyers is a bigger influence on interest rates than the stock market.
Catie Watson spent three decades in the corporate world before becoming a freelance writer. She has an English degree from UC Berkeley and specializes in topics related to personal finance, careers and business.