Here are a couple examples of why mortgage rates don't follow the 10-yr Treasury that I thought would be useful for our members.
- More Risk. The 10-year Treasury is backed by the full faith and credit of the US government. Mortgage bonds are backed by the full faith and credit of American homeowners. If the economy enters into a bad recession, the US government is unlikely to default on its debt. However, if homeowners lose their jobs, they may default on their home loans, causing mortgage bond investors to lose money. Therefore, mortgage bonds carry more risk than US Treasuries. For this reason, when times are tough, the “spread” tends to widen between mortgage bond yields (mortgage rates) and US Treasury yields.
- Pre-payment Risk. If mortgage rates drop, this causes homeowners to refinance their mortgages. When that happens, mortgage bond investors are forced to trade in their higher-yielding mortgage bonds for lower-yielding mortgage bonds. FNMA/FHLMC/GNMA loans are guaranteed by the US so it’s really primarily prepayment risk and some liquidity risk that drives the spread to Treasuries.