How MBS-to-Treasury Spreads Affect Interest Rates

Most people think mortgage rates move in line with the Fed, but that’s only half the story.   When the Fed cuts rates, mortgage rates can come down over time, but not right away. The real driver is the 10-Year Treasury yield. If you compare 30-year mortgage rates with the 10-Year Treasury over the last few decades, they’ve tracked almost identically. That’s because investors who buy mortgage-backed securities use the 10-Year Treasury as a benchmark for safe, long-term returns.   Historically, mortgage rates sit about 1.75% higher than the 10-Year Treasury. In recent years, that gap (called the spread) has widened to 2–2.25% because of inflation and market volatility. As inflation cools and stability returns, that spread should narrow again. Combine that with expected Fed rate cuts, and we could see mortgage rates in the mid-5s in the months ahead.   The takeaway is simple: don’t focus on headlines, focus on data. Understanding what actually moves rates helps smart buyers and agents make confident, strategic moves while others wait.

The 10-year Treasury borrowing rate is 3.9%. Under normal circumstances and based on a normal historical spread between the two interest rates, the average mortgage rate should be 5.6% to 5.9% today. The mortgage rate spread is instead still abnormally high (at 250 basis points) and therefore yielding 6.4% average mortgage rate. One reason for the large spread is due to the cloudy balance sheet among small and regional banks who have exposures to deteriorating office loans. To raise cash, some banks are selling off mortgage loans and mortgage-backed securities. The Federal Reserve’s own reduction in holdings of Fannie and Freddie backed mortgage backed securities is also at play.