How Does the Stock Market Influence Mortgage Rates?

You lock into a fixed-rate mortgage at 5.5% when you first buy your home, and by the time you’re up for renewal, the mortgage rate is down to 3%.

While you’re not exactly disappointed that you’re now offered a lower interest rate – which equates to a lot of money saved in interest payments over the life of your mortgage – you can’t help but wonder why mortgage rates are prone to such wild fluctuations.

We’ve been in an extremely low mortgage rate environment over the past few years, which has made buying a home somewhat more affordable. But anyone – Baby Boomers in particular – who purchased a property back in the early 1980’s surely remembers when rates were ridiculously high – as high as 18.45%, to be exact.

Imagine paying for a home with that monster of a rate attached to the mortgage? It’s easy to understand how many homeowners ended up losing their homes simply because they were upside down in their equity.

The reasons for mortgage rates moving up and down like a roller coaster are wide in range, but the stock market is certainly a big player in the game.

Mortgage-Backed Bonds’ Influence on Mortgage Rates

While there are a few factors that contribute to which direction mortgage rates run in – namely inflation – the stock market is a key influencer.

But it’s helpful to take a step back to really get the gist of how mortgage rates are essentially determined. Mortgage-backed bonds (MBS) are at the root of changes in mortgage rates. Fannie Mae and Freddie Mac issue these MBS’s, which are backed by the interest that’s paid out by mortgage holders. Similar to the stock market, MBS’s are traded on an exchange.

An inverse relationship exists between mortgage rates and the price of MBS’s; when MBS prices go up, mortgage rates do down. The reverse is also true. 

Essentially, when there’s an increase in economic fear, there tends to be a mass exodus of investors from the stock market. Instead, these investors hedge their funds in safer Treasury bonds. With demand spiking for these bonds, yields drop – there’s simply no need to keep them up to attract investors. 

Conversely, a rally in the stock market encourages investors to sell these bonds in favor of purchasing stocks.

All this is based on the notion that both the stock and bond markets are vying for the same investment money. In other words, investor will choose to either invest money in the stock market or the bond market.

As a general rule of thumb, investors choose stocks over bonds when a greater return over time is sought, but stocks are also associated with heightened volatility. On the other hand, the returns on bonds are usually a lot lower compared to stocks, but they’re generally less volatile.

For this reason, investors typically turn to bonds to hedge their funds when the overall market and economy is unstable. 

If the stock market is down, it means investors are liquidating their stocks and buying into bonds. When this happens, bond prices soar, while mortgage rates plummet. And when the stock market is bullish, investors are likely selling their bonds and switching over to a more stock-heavy investment portfolio.

In this environment, mortgage rates rise as bond prices tumble following a surge in supply.

Of course, there are a host of other factors that influence how mortgage rates behave from one day to the next. But the stock market certainly has it’s role in the whole process.

Nevertheless, rates are incredibly low these days, and have been hovering around historical lows for years. It will be interesting to see how fast and far they climb in the near future given the current economic turmoil across global markets.