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Market movements shape the mortgage playing field

The mortgage food chain So bonds are down, the Dow is up and the yen carry trade went sour for an investor up North. Chances are these headlines blur into meaningless babble for most mortgage hunters. But it's such market movements that affect the price of home loans everywhere.

Take the mortgage-backed security. It's an investment made up of several loans that are bundled together and yield roughly 0.50 percent less than a borrower's interest rate. A 7 percent mortgage held by a bank customer, for example, yields about 6.50 percent to a mutual fund or other investor.

Rise and fall
The yields on those mortgage-backed securities generally rise and fall along with yields on U.S. Treasury bills, notes and bonds because those government securities reflect the overall direction of interest rates. Thirty-year fixed mortgage rates, for instance, usually move in tandem with the yield on the 10-year Treasury Note because the mortgages often expire in about the same number of years it takes the note to mature. Few 30-year mortgages stay on the books for 30 years because people refinance, move or otherwise retire the debt early.

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Many events can help send Treasury yields lower, but tensions that accompany signs of slower economic growth typically have the greatest impact. These signs come from government and private sector research reports issued almost daily. They catalog things such as new home construction rates, consumer spending and output from the country's factories and mines.

The supporting cast
Other things that can spur lower yields include a Federal Reserve rate cut (two have kicked in during the last month) and global market turmoil. Recent international upheaval has driven investors to snap up safe investments, including Treasuries, which sent Treasury yields tumbling.

While mortgage rates traditionally move in tandem with Treasury yields, when yields decline sharply over a short period of time, mortgages generally don't drop at the same pace because of what happens to mortgage-backed securities.

As soon as mortgage rates start to slide, people begin to refinance. Every time a loan is paid off early, the mortgage-backed security of which it is a part slips in value. Suddenly the investor needs a new investment, either another mortgage-backed security or, perhaps, something safer, like a Treasury note.

If the investor opts for another mortgage-backed security, he will want to be compensated for the newly increased risk level. As a result, he demands a higher yield, pressuring rates upward on the mortgages that will back the new security.

Investors who leave the mortgage-backed security market for the higher ground of Treasury notes reduce demand for mortgage-backed securities, and reduce competition. That further drives up mortgage rates.

Inflation and other ills
Inflation, of course, remains the hidden enemy of all kinds of debt securities because it drives rates up across the board. It generally is born of excessive economic growth, or an overabundance of money in circulation. The United States has escaped inflation for some time now because the various problems in Asia, Russia, Latin America and elsewhere have helped check the country's growth. But most adults can remember the effects of inflation on mortgages: Just consider that mortgage rates were in the teens during the mid-1980s.

Supply and demand also pull and tug on the price of a mortgage. Experts say people stand to save a bundle if they're buying a property in an area where a lot of lenders compete for a little business. That especially holds true when there's a slowdown in the housing market because companies accustomed to higher loan volumes want to keep things busy by cutting deals.

-- Posted: Oct. 29, 1998
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See Also
Main story: Investor demand drives mortgage prices
Table: How the mortgage dollar circles the block
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The basics: Mortgages
Definitions: Mortgage terms
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