When you’re thinking about buying a home or refinancing, mortgage rates are probably one of the first things on your mind. But have you ever wondered WHY mortgage rates fluctuate? A big part of the answer lies in something that might surprise you: the 10-year U.S. Treasury bond yield. Let’s break it down in simple terms.

How Are Mortgage Rates and 10-Year Bond Yields Connected?
Mortgage rates don’t move randomly; they tend to follow the ups and downs of the 10-year Treasury bond yield (yield is another term for interest rate). Here’s why: investors consider Treasury bonds to be very safe investments because they are backed by the U.S. government. On the other hand, mortgages are riskier because there’s always a chance that borrowers might default (miss payments). To compensate for that extra risk, mortgage rates are usually a little higher than the yield on a 10-year Treasury bond.
So, when the 10-year bond yield rises, mortgage rates usually go up, and when the yield falls, mortgage rates tend to drop. This difference between mortgage rates and the bond yield is called the risk premium.
What’s the Historical Risk Premium?
Typically, the risk premium (the gap between the mortgage rate and the 10-year bond yield) has averaged around 1.5 to 2 percentage points. This is a healthy spread that reflects the extra risk lenders take on when giving out mortgages.
Why Has the Risk Premium Been Above Average Since COVID?
Since the COVID-19 pandemic, the risk premium has shot above that historical average. Why? Several reasons:
Economic Uncertainty: During the pandemic, nobody really knew how the economy would react. Would people be able to pay their mortgages? This uncertainty made lenders cautious, pushing them to increase the risk premium to safeguard their money.
Inflation and Rising Rates: Inflation surged post-COVID, and the Federal Reserve started raising interest rates to cool it down. Higher inflation and rate hikes led to more expensive mortgages, but the 10-year bond yields didn’t rise as quickly. This widened the gap between the two.
Mortgage Market Volatility: With fewer homebuyers and more economic uncertainty, mortgage lenders had to factor in extra risk, further pushing the risk premium higher.
When Will the Risk Premium Come Back to Normal?
So, when will we see this gap narrow and the risk premium return to its historical average? It’s hard to say exactly, but experts believe it could take some time. Factors like inflation stabilization, Federal Reserve policies, and overall economic stability will play big roles.
Many believe the risk premium could return to normal levels sometime in late 2024 or 2025.
Once inflation is tamed, and the economy settles into a steady rhythm, the mortgage rate should start aligning more closely with the 10-year bond yield.
So Are Mortgage Rates Already Coming Down?
You might be wondering if mortgage rates are already starting to drop, by proactively factoring in the high likelihood that the Fed will lower rates at their next meeting on September 18. There actually may be some legitimacy to this and why we’ve witnessed reducing mortgage rates over the last few months. However, it’s likely not a significant factor at this point. While there’s optimism that the Fed’s potential rate cuts will eventually lead to lower mortgage rates, we’re not quite there.
The good news? If the Fed does cut rates as expected, it could lead to a ripple effect where mortgage rates gradually decrease, giving homebuyers and homeowners looking to refinance a bit of relief. But keep in mind, mortgage rates don’t always respond immediately to Fed rate cuts, so it may take a little while before we see noticeable reductions.
In Conclusion
The relationship between mortgage rates and the 10-year Treasury bond yield is key to understanding why rates rise and fall. Since COVID, the risk premium has been higher than usual due to uncertainty and economic volatility, but experts are hopeful that we’ll see it return to normal in the coming years. And while a Fed rate cut might not lower mortgage rates right away, there’s reason to believe we could see some easing in the near future.
If you’re in the market for a home or thinking about refinancing, now’s the time to keep an eye on these trends!
You can monitor the trends on Mortgage News Daily and see the actual spreads from current all the way back to the 1980s. Check it out here.
I hope this helps clears things up! If you have any more questions about mortgage rates or the housing market, feel free to get in touch.
Cheers,
-Joe
Listen to the podcast for this blog article: note: this podcast is AI created from my blog article.
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