How Are Mortgage Rates Tied to the 10-Year Treasury Yield and Why Does It Matter?

Mortgage rates are closely tied to the 10-year Treasury yield, which is a benchmark interest rate set by the US government.

The 10-year Treasury yield is a key indicator of market sentiment and economic expectations, and it influences the cost of borrowing for mortgage lenders.

Lenders use the 10-year Treasury yield as a benchmark to set their own mortgage rates, as it reflects the overall level of interest rates in the market.

This means that when the 10-year Treasury yield rises, mortgage rates tend to increase as well, making it more expensive for borrowers to buy or refinance a home.

A 1% increase in the 10-year Treasury yield can result in a 0.25% to 0.5% increase in mortgage rates, which can add thousands of dollars to the cost of a mortgage over the life of the loan.

The relationship between mortgage rates and the 10-year Treasury yield is a crucial consideration for borrowers, as it can have a significant impact on their monthly mortgage payments and overall financial situation.

Mortgage rates are influenced by various factors, but one of the key drivers is the 10-year Treasury rate.

In recent months, the 10-year Treasury rate has been higher than the 7-year Treasury rate, which is a reversal of the trend seen in 2022 and 2023.

The duration adjustment, which is the difference in duration between mortgage rates and the 10-year Treasury rate, has decreased, meaning it's doing less to push up the spread between mortgage rates and the 10-year Treasury rate.

Prepayment risk, which is the risk that borrowers will refinance their mortgages at lower rates, has also decreased due to lower interest rate uncertainty.

Borrowers with mortgages are affected differently by interest rate changes, and if rates fall, they can prepay and refinance their mortgages at lower rates.

Measures of interest rate uncertainty, such as the MOVE Index, are currently lower than in late 2023.

The primary-secondary spread, which reflects the costs of issuing mortgages and the pricing power lenders have, has increased since the last analysis.

Lenders face greater risk that borrowers will renegotiate to borrow at lower rates in an environment where mortgage rates are falling and expected to continue to fall.

The option-adjusted spread (OAS) has also declined since late 2023, but the exact reason for this decline is uncertain.

Mortgage rates generally track the rate on 10-year Treasury bonds because both instruments are long-term and because mortgages have relatively stable risk.

The spread between mortgage rates and Treasury bond rates fluctuates for various reasons, including changes in credit conditions and interest rate uncertainty.

The difference between the two rates can be broken down into three components, as shown in Figure 3: the primary-secondary spread, which reflects the costs of mortgage issuance; an adjustment for mortgage duration and prepayment risk; and the remaining spread, which reflects changes in demand for mortgage-related assets.

On average, the margin between Treasury bonds and mortgage-backed securities is approximately 1.7 percentage points, a figure which may appear small but has an impact on loan payments.

A wider spread indicates that mortgage rates are higher relative to Treasuries, which could be due to factors such as increased credit risk or anticipation of economic changes.

Here are some key factors contributing to the spread between mortgage rates and 10-year Treasury bond rates:

These factors can cause the spread to fluctuate, making it essential to understand the underlying dynamics to make informed decisions as a borrower or investor.

The relationship between mortgage rates and treasury yields is a complex one, but it's essential to understand if you're planning to buy or refinance a home. Mortgage rates are primarily determined by investor demand for mortgage bonds, which are influenced by the market's expectations for where inflation, economic conditions, and interest rate decisions by the Fed are headed.

The 10-year treasury yield is often viewed as the main benchmark for the direction mortgage rates are headed, but it's not the only factor at play. While rates on both investments move together, there's an important difference between them. Mortgage rates are usually a bit higher, due to their increased risk.

Over the past five years, the average difference between the 10-year Treasury rate and mortgage rates has been roughly 2.25%. This means that if the 10-year Treasury rate is 4%, mortgage rates might be around 6.25%. This is because mortgage rates are more sensitive to changes in the economy and inflation.

The relationship between mortgage rates and treasury yields can be seen in the correlation between the two. According to Freddie Mac data, the 10-year Treasury yield and mortgage rates have had a strong correlation of about 0.85 over the last decade. This means that they move together around 85% of the time.

Here's a rough estimate of how the 10-year Treasury yield can affect mortgage rates:

Keep in mind that this is just a rough estimate and actual mortgage rates may vary depending on other factors such as your credit score, loan term, and location.

Mortgage rates are influenced by the spread between mortgage rates and Treasury yields. A wider spread indicates higher mortgage rates relative to Treasuries.

A wider spread can be due to increased credit risk or anticipation of economic changes. This means lenders perceive more risk in lending money via mortgages than in purchasing government bonds.

A narrower spread suggests similar returns for both mortgages and Treasuries. It shows lenders perceive less risk in lending money via mortgages than in purchasing government bonds.

The spread can fluctuate based on market conditions, affecting mortgage rates.

Bond maturities play a significant role in the financial markets, with longer-term bonds typically offering higher returns due to the greater risk associated over time, known as the 'time premium'.

Bonds with longer terms tend to have higher yields than those with shorter terms, making them more attractive to investors. As a result, when people buy more long-term treasuries, yields fall, making them less attractive relative to shorter-term bonds.

Treasury yields have a significant impact on other bond yields, as investors often compare returns across different types of bonds. If Treasury yields increase, corporate and municipal issuers must also increase their rates to attract buyers.

Here are the main types of bonds and their characteristics:

A wider spread between mortgage rates and Treasuries indicates higher mortgage rates relative to government bonds, which could be due to increased credit risk or anticipation of economic changes.

The spread between Treasury bonds and mortgage-backed securities (MBS) fluctuates based on several key elements, including inflation expectations, monetary policy shifts by the Federal Reserve (Fed), and supply-demand dynamics within bond markets.

Inflation expectations play a significant role in shaping the spread, as investors adjust their expectations of future inflation when making investment decisions. The Federal Reserve's monetary policy also has a substantial impact, as changes in interest rates affect the cost of borrowing and the value of investments.

The spread between Treasury bonds and MBS is typically around 1.7 percentage points, a figure that may seem small but has a significant impact on loan payments.

Here's a breakdown of the factors contributing to the spread:

By understanding these dynamics, you can gain a better grasp of the bond market and make more informed investment decisions.

Bond maturities play a significant role in the financial markets, particularly when it comes to bond yield.

Bonds with longer terms typically offer higher returns than those with shorter terms due to the greater risk associated over time, known as the 'time premium'.

When people buy more long-term treasuries, their price increases, causing yields to fall.

This makes long-term bonds less attractive relative to shorter-term bonds.

As a result, the bond market influences interest rates in another way.

So, whether you're investing in bonds or planning a mortgage loan, keep an eye out for these indicators.