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Why Mortgage Rates Rise When the Fed Cuts Rates

Short term loans like car loans, credit cards and home equity loans are automatically lowered with Federal rate cuts because they are based on the Prime rate. Longer term loans such as mortgages aren’t because they are based on competing investment options, for instance investing in stocks rather than real estate. When the Fed cuts rates the stock market takes it as an “all is well” signal, making stocks a more appealing investment. This causes money to be removed from the mortgage backed securities and bond market and put into the stock market, thus lowering the demand for mortgage backed securities and bonds. Now the companies that issue bonds and mortgage backed security investments raise the rates to entice investors back into the fold with higher yields, essentially higher rates. Since the yields are rising, so must the rates on the underlying mortgages.

If yields/rates rise on mortgage backed securities then the actual rates on the underlying mortgages must also rise. That is why mortgage rates can rise when the Fed cuts interest rates.


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