How Do the Bond and Mortgage Markets Intertwine?
There are a plethora of factors that affect the mortgage market and interest rates, including inflation, the Federal Reserve monetary policy, the rate of economic growth, and housing market conditions. But Mortgage Loan Officers should be aware of the less visible elements that impact the mortgage industry, including the bond market. Let’s look into what a bond is and uncover how the bond market affects mortgage rates.
What Is a Bond?
According to Investopedia, bonds are “fixed-income instruments that represent a loan made by an investor to a borrower (typically corporate or governmental)”. Simply put, they are units of corporate debt issued by companies and pooled together as tradable assets. The company issuing the bond is considered a borrower; the investors who buy those bonds are considered lenders.
Per InCharge’s website, “investors buy bonds because they will receive interest payments on the investment. The corporation or government agency that issues the bond signs a legal agreement to repay the loan and interest at a predetermined rate and schedule.”
To break this concept down further, we’ve defined some important terms below:
- Issue Price: The price for which the bond issuer sells the bond originally.
- Coupon Rate: Also known as the coupon or coupon payment, the coupon rate is the annual interest rate that the bond issuer will pay based on the face value of the bond.
- Face Value: The amount the bond will be worth when it hits its maturity date.
- Coupon Date: The date upon which the bond issuer makes interest payments to the bondholder via coupon payments.
- Maturity Date: The date upon which the borrower must repay the principal amount of the bond in full or risk defaulting. After this date, the interest payments that were regularly paid out during the life of the bond cease. Bonds can be considered short-, medium-, or long-term, depending on how far out their maturity date is from their date of creation. All bonds have maturity dates, but not all bonds reach maturity.
To illustrate further, say that Jon buys a 10-year, $20,000 bond that pays 5% interest semi-annually. In exchange, Jon will receive 5% interest, or $1,000, on his bond every six months. If he holds onto his bond for all 10 years and it reaches maturity, he will be repaid the $20,000 he initially invested into the bond, as well as the $20,000 he gained in interest along the way.
Still confused about how bonds work? Check out this video by Khan Academy:
The Relationship Between Bonds and Mortgages
Bonds and mortgages have an inverse relationship; when bond prices are high, mortgage rates are low and vice versa. According to Rocket Mortgage, this inverse relationship is caused by mortgage lenders tying their interest rates to Treasury bond rates: “When bond interest rates are high, the bond is less valuable on the secondary market, [which] causes mortgage interest rates to rise.” It’s important to note that the majority of mortgage lenders keep their interest rates slightly higher than bond interest rates because they “tend to attract similar investors.”
In other words, the bond value increases when bond interest rates fall, causing mortgage lenders to lower interest rates. The liquid value of a bond is higher when bond interest rates are lower, making it easier to sell the bond on the secondary market.
Keep in mind, not all mortgage rates are affected by bond interest rates. Lenders only affix fixed-rate mortgages to bond rates.
While it’s well known that mortgage rates are impacted by the housing market, inflation, and the growth of the economy, it’s important to understand underlying factors that also affect mortgage rates — like bonds. If you’re interested in what the mortgage market is doing, check in on patterns in the bond market as well. Good luck!
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