Why Oil Prices Spike Mortgage Rates

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NEW YORK (MainStreet) — With the U.S. invading Libya and political unrest unraveling across other key Arab states like Egypt and Syria, the price of oil is skyrocketing these days. What does that mean for mortgage rates? Quite simply, higher rates and more expensive mortgages.

Higher oil prices tend to push interest rates—and therefore mortgage rates—higher because the health of the U.S. dollar is tied to oil prices. The dollar is the primary currency measured against oil prices, and higher oil prices reduce the value of the buck.

Right now, the price of a barrel of crude is about $108.00, a 30-month high. Factors impacting the price of oil include the U.S.-led military intervention in Libya and the continued economic fallout from Japan’s earthquake. Libya may only account for 2% of the world’s oil production, but Arab nations are understandably anxious about any military and political unrest in the region. Even without the Libyan situation, the “normal” price of crude oil would be about $90-$100 per barrel.

The price of running a business or filling a tank of gas to commute to work every week (or more) also pushes up mortgage rates. So with more money needed to keep industries rolling, as well as to keep Americans’ cars on the roads and lights on in their homes, that means less cash that businesses and consumers will have for other economic needs. That then slows economic activity, as businesses raise prices to keep profits coming, which can also trigger higher inflation, a scenario that usually leads to higher mortgages rates.

Inflation is a particularly strong driver of mortgage rates. Bond investors know all too well that fixed income securities provide a “fixed” return. Inflation lowers the value of bonds (like U.S. Treasuries) that fall in value, as investors stampede to sell them and look for a higher-returning investment (like stocks). As the prices of U.S. treasuries decline, the government has little choice but to raise interest rates to attract new buyers.

The good news, if there is any in this scenario, is that investors do carry a great deal of clout. If they feel the global (or regional) economy is in peril, they may take their money out of stocks and pop their cash back into the bond market for greater financial safety (especially as the Middle East calms down). With less money in the stock market and more cash in bonds, interest rates should fall and take oil prices down with them.

But that’s a big “if” right now. Inflation is a tough lion to tame, and it doesn’t slow down overnight. Granted, Japan’s crisis will abate, and eventually the Libyan crisis will fall off the front pages of global newspapers and websites. Still, nobody’s circled a date on the calendar for when that will happen, and the uncertainty that goes with these geopolitical events only leads to further instability for oil prices, and by extension, mortgage rates.

The best move to make for mortgage shoppers is to jump on a low rate right now and lock it in before the price of a mortgage goes even higher.

—For the best rates on loans, bank accounts and credit cards, enter your ZIP code at BankingMyWay.com.

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