Where Do Mortgage Rates Come From?

Article Summary:

Mortgage Rates…Whether it concerns the issue of home affordability, or simply the condition of the residential real estate market, mortgage rates are front and center concerning these issue. That said, this article will explore…

The Big Picture: 30-year mortgage rates just hit a 1.81 spread to the 10-year treasury bond, which is the closest they’ve been to historical norms for quite some time.

The Catalyst: A single Truth Social post from President Trump regarding a $200B MBS purchase (Will President Trump’s $200 Billion Mortgage-Backed Securities (MBS) Plan Actually Lower Your Mortgage Rate?).

The Catch: While headlines are screaming increased “affordability,” we speculate about whether this yield compression is a permanent shift or a temporary, news driven, market blip.

The Loan Officer Quotes A Potential Homebuyer A Mortgage Rate…But Where Did That Number Come From?
If you’ve been watching the news lately you’ve likely seen a lot of headlines that talk about “yield spreads,” “the 10-year Treasury bond yield,” and “Trump’s proposal featuring the purchase of mortgage-backed securities or MBS.”

But for the average person just trying to buy a home and get a handle on what their monthly payment might be, all of the financial jargon can sometimes sound like a different language.

Some wonder why mortgage rates hit record lows in 2020, soared to nearly 8% in 2023, and then suddenly dropped again this week?

The answer isn’t a mystery, but is actually based on a formula. This article breaks down how a 30-year mortgage rate is determined by a lender, and why it has become so volatile in recent days.

Even so, rates can vary lender to lender based on a variety of factors that may be unique to them, including the lenders appetite to lend. Lenders wanting to lend may offer a lower rate, while those more cautious on the market may offer a higher rate.

1. 30-Year Mortgage Rate Foundation: The 10-Year Treasury Note
Most people assume mortgage rates follow the Federal Reserve’s “Fed Funds Rate.” While they are related, they aren’t the same. As a long-term loan, your mortgage is actually benchmarked to the 10-year Treasury note.

Think of it this way: Investors who buy 10-year bonds are making a bet on what the economy will look like for the next decade. They look at:

Monetary Policy: What will the Fed do over the next 10 years?

Inflation: Will the dollars they get back in the future be worth less?

Economic Growth: Is the economy screaming ahead or heading for a “safe haven” recession?

When the 10-year Treasury yield moves, mortgage rates almost always follow in lockstep.

2. The “Mortgage Spread”
Lenders don’t just give you the Treasury rate; they add a “spread” (an extra margin) on top of it. This spread covers the risks and costs of the mortgage business. It’s made of two parts:

The Primary Spread: This covers the basic costs involved in originating the loan, paying the staff, servicing the mortgage, and the profit margin for the lender.

The Secondary Spread: This is the “Risk Premium.” Unlike a government bond, a mortgage has prepayment risk (you might refi and the investor loses interest) and credit risk (the risk of default). To incur those risks, investors demand a higher rate than they would for a “risk-free” Treasury bond.

3. The Fed’s Invisible Hand
A significant driver of the spread is the. composition of the Federal Reserve’s balance sheet.

Quantitative Easing (QE): When the Fed buys billions in mortgage bonds, they are a “non-economic buyer.” They don’t care about the yield, which drives the spread lower and rates down (as seen in 2020). The proposed purchase of $200 billion mortgage-backed securities would be an example of this, and in real life we saw the 30-year mortgage rate temporarily drop below 6%.

Quantitative Tightening (QT): When the Fed stops buying, private investors have to step in. These investors do care about the yield, so they demand a higher rate, which drives the spread upward.

4. Why 2026 is Different: The “Trump Effect”
Following the rate cuts in late 2024 and 2025, the market began digesting a “stronger-than-expected” economy and stickier inflation. This pushed the 10-year Treasury back up.

However, we just saw a massive shift. As mentioned above, the President’s plan to have Fannie and Freddie buy $200 billion in MBS is a direct attempt to “force” the spread lower.

By creating artificial demand for mortgage bonds, the administration is trying to compress that yield gap, even if the Fed stays on the sidelines.

The Bottom Line
Historically, the “mortgage spread” averages about 1.76 percentage points. In 2023, it blew out to nearly 3%. Today, following the recent news, it has compressed to 1.81.

Is it a permanent fix? That depends on whether the $200 billion injection is a one-time “blip” or a long-term commitment. For homebuyers, the math is simple: lower spreads mean lower rates, but without more houses hitting the market, those savings might just get swallowed up by higher home prices.

Components of the Mortgage-Treasury Spread

See above