Why Do Mortgage Rates Increase While Savings Account Interest Rates Stay Low?

The current state of financial markets poses a puzzle to many: why are mortgage rates on the rise, yet savings account interest rates are surprisingly low? To understand this phenomenon, we must delve into the intricacies of how banks operate and the factors influencing these rates.

Government Unpredictability and Mortgage Rates

The reason for increasing mortgage rates can be traced back to the political landscape. Uneven government policies and political instability have led banks to question the reliability of federal government support. As the stability and consistency provided by a properly functioning government are essential for financial systems, the current environment of instability in the United States and many other nations can explain higher borrowing costs. While the federal government continues to recover from the impact of the pandemic, banks remain cautious, driving mortgage rates upwards.

Bank Profits and Business Models

Banks operate on a principle where mortgage lending is their primary source of profit. When you take out a mortgage, you pay the bank for the use of borrowed funds, which is how they generate revenue. On the other hand, banks do not profit directly from savings accounts—they pay you a small rate for holding your money in the account. This rate is generally lower than what they charge for lending the money, creating a profit margin that funds their operations and shareholder returns.

The Business of Savings Accounts

Banks benefit from savings accounts by earning a spread between what they pay depositors and what they charge borrowers. This is the case for the majority of retail savings accounts, which often cost banks more to run than the interest they pay out. As a result, there is no strong incentive for banks to invest in increasing rates to attract more savers.

Historically, banks were more reliant on savings deposits to fund mortgages, which is why they maintained higher interest rates to attract savers. However, the rise of the secondary mortgage market allows banks to sell mortgages to investors and keep a cut, effectively making them less dependent on traditional savings accounts. They can now rely on these sales to fund mortgages and maintain credit supply without needing to retain a large pool of savings.

The Dual Nature of Financial Products

In simpler terms, a typical bank might offer a savings rate of 3% per annum and lend out at 5% per annum. With a deposit of ￡100, the savers receive ￡3 in interest annually, while the bank uses that ￡100 to loan out to someone for a mortgage at 5%, generating ￡5 annually. The bank then passes on ￡2 to the saver to cover operational costs and generate profits for shareholders.

While this example simplifies the business of finance, it reflects the relationship between savings and lending. Additionally, savings products are usually offered for shorter terms, typically two years, compared to long-term mortgage finances, which can extend to 25 years. This disparity, along with changing interest rates, tax impacts, and written-off mortgage debt, contributes to the divergence between mortgage and savings rates. The Treasury Department within banks plays a critical role in managing excess cash through deposits and borrowings on the money market, adding another layer of complexity to this relationship.

Conclusion

In summary, the increasing mortgage rates and relatively low savings interest rates can be attributed to factors such as political instability, business models within banks, and the changing dynamics of traditional financial products. Understanding these elements can help clarify the complex interplay between these financial instruments and provide insight into future market movements.