Awaiting the Fed’s next move? Watch 10-year T-notes

Will interest rates finally begin a sustained decline?

Many mortgage lenders and borrowers expect answers when the Federal Open Market Committee meets Oct. 28 and 29.

But another indicator that’s available now can tell us a lot about the direction of interest rates — and the direction the Fed might take later this month.

That indicator is the 10-year Treasury bond, also known as the 10-year T note.

What do 10-year Treasury bonds have to do with mortgage rates?

When 10-year Treasury yields rise and fall, average mortgage rates tend to follow. Mortgage rates and bond yields are tethered because, like the 10-year note, the average mortgage lasts about 10 years.

Why the 10-year note instead of the 30-year treasury yield? Because even homebuyers who use 30-year loans tend to sell or refinance long before their loan’s 30-year term ends, often within 10 years.

Along with influencing mortgage rates, indicators like the 10-year note can also influence Fed decisions about rates because the Fed cares about the overall condition of the economy, and bond rates help paint that picture.

Why Fed decisions may matter less than many borrowers think

Thanks to never-ending news surrounding Fed meetings, many home buyers and refinancing homeowners think the Federal Reserve sets mortgage rates directly.

In reality, Fed decisions are among several variables that affect the cost of a mortgage. A Fed cut doesn’t always mean mortgage rates will follow suit.

We saw this reality playing out as recently as September when the Fed cut its benchmark borrowing rate by a quarter point.

In response to that cut, mortgage rates held steady and even ticked up for a while. Why? Because mortgage rates had already fallen some, in anticipation of the Fed’s decision, and because 10-year Treasury note yields increased.

Why the 10-year T-note now matters more than usual

The Fed typically factors in government economic data like jobs reports and inflation trends. With the current government shutdown blacking out most of this data, the Fed will have to find other ways to assess the health of the economy as it makes decisions about rates.

This lack of other economic data could put the 10-year T note more in the Fed’s spotlight this cycle.

Why is the 10-year T-note so important to mortgage rates?

As we said above, a 10-year T-note matures at about the same time as the average mortgage. But the relationship between these two investments goes beyond timing.

Ultimately, it’s about supply and demand. When stock prices in the Dow and the S&P 500 fall, investors take their money out of stocks and put it in safer investments, like government bonds, including the 10-year note.

This increased demand for T-notes increases their price. And a higher price lowers the yield investors can earn on the note.

That’s how volatility in the S&P 500 and other stock indexes can ultimately lower borrowing prices for ordinary homeowners and home shoppers.

That’s not to say the Fed decisions don’t matter

While it’s not the all-powerful determiner of mortgage rates some borrowers think it is, the Fed matters a lot. It sets monetary policy for the U.S. economy so its decisions reverberate around the globe.

Other variables, like the price of Treasury bonds, react to Fed policy, not vice versa.

So, for home buyers and refinancing homeowners, a lot still rides on the Fed’s October decision:

• If the Fed cuts rates by 25 basis points (0.25%) as most economists expect: Mortgage rates could benefit some, though it’s no guarantee, as September’s rate cut showed us.
• If the Fed cuts rates by more than 25 basis points: This more aggressive approach could create short-term increases in mortgage rates, though there’s a good chance it could also send long-term mortgage trends downward.
• If the Fed holds rates steady: Mortgage rates could gradually inch back up closer to the 7% averages we saw earlier this year.

What, exactly, does the Fed rate do?

When the Fed increases or decreases a rate, it’s changing its Overnight Bank Funding Rate (OBFR). This rate measures the cost banks charge each other to transfer funds to meet federal requirements.

The OBFR has a direct impact on the Prime Rate which lenders use for home equity products. If the Fed drops its rate by 0.25%, the Prime Rate always moves by the same amount.

Home equity lines of credit (HELOCs), for example, base their variable rate on the Prime Rate, so these changes can directly impact a homeowner’s monthly home equity borrowing costs.

Should borrowers wait to see what the Fed and bond yields do next?

Economic conditions influence mortgage rates, and average rates set the context for individual borrowing costs.

Since they already own the home, refinancing homeowners like to wait until average rates fall before locking in their refinance. This makes sense. Even a 0.125% drop can save long-term cash.

Home buyers, on the other hand, have more to risk by waiting. Waiting for a better rate could mean violating the purchase contract or messing up the timing with the home they’re selling.

Since October’s meeting likely won’t change mortgage rates dramatically, home buyers should continue with their plans if possible. They’ll likely save more by becoming homeowners, and starting to build equity sooner, than they’ll save by waiting months or years to buy.

How can buyers estimate today’s real costs before applying for a mortgage?

Before applying for a mortgage, borrowers should estimate their own costs with a mortgage calculator.

A mortgage pre-approval provides a more accurate estimate of loan costs because it’s based on the individual borrower’s unique financial situation.

Better’s AI-driven pre-approval can show results in as little as three minutes.

...in as little as 3 minutes – no credit impact