Bond Market & Mortgages

Yields on 10-year and 30-year Treasury securities are typically used to set long-term mortgage rates. Loans with short initial terms (1-, 3-, and 5- year ARMs, e.g.) are pegged to shorter-term securities. So when bond yields drop, typically, conventional mortgage rates fall as well. Conversely, when yields rise, so do mortgage rates.
Why? If a lender chooses to sell your mortgage loan to an investor, the lender will likely use Treasury yields as a benchmark for value.

The bond market refers to people and entities involved in buying and selling of bonds and the quantity and prices of those transactions over time. Participants in the market trade bonds issued by corporations and various government bodies.

Because of the relationship between bond prices and interest rates, references to the "bond market" are often used to indicate changes in interest rates or the shape of the yield curve. Other names for the bond market are the credit market and the debt market.

Don't be confused by bond market terminology however, they often confuse people. When you hear or see bond prices displayed, make sure you understand that bonds have both a 'price' and a 'yield', and they move opposite of each other. So, when CNNfn says "the bond market rallied today" or that 'bonds closed up 5/32nds today", that means that the price of the bonds went up, so the yield went down. A decrease in the yield is good news for mortgage rates.

If you don't understand how prices can go up if the yield is falling, you are not alone. The concept is actually pretty simple. Let's say a 10-year bond, with a $1,000 face value is sold with a coupon rate or yield of 5%. If a year later the current interest rate environment is 5#, then the bond will sell for $1,000 on the secondary market (where one bond owner sells to another bond owner). What if the current rates rise to 6%? In that case, no one will want to buy a $1,000 bond yielding 5% when they can spend the same $1,000 to buy a $1,000 bond yielding 6%. So, in order to sell the 5% bond at a current market yield, bond buyers will only be willing to buy the 5% bond if they can buy it at a discount. If that same bond were discounted to about $910, then over the remaining 9 years it will pay a 5% coupon, PLUS it will be worth $1,000 in 9 years, which will mean that is will effectively appreciate at about 1% a year, yielding a 6% annualized return. So, when interest rates rose, the price of the bond had to fall to yield the greater return demanded by investors. Conversely, if interest rates fall, the price of the bond will rise to reduce the return on the bond.

Unlike the Prime Rate these bonds are directly correlated with current mortgage interest rates.

The daily buying and selling of T-bonds. Lenders pay close attention to this market, because as the yields of bonds go up and down, fixed rate mortgages do close to the same thing. The same variables that affect the Treasury Bond market also affect mortgage rates at the same time.