The Definition of Mortgage Spread

Mortgage spread represents the difference in interest rate between the 10-year United States Treasury bill and the average rate on a 30-year mortgage. Typically, mortgage rates remain about 1.5 percent above the rates being paid on 10-year Treasuries. However, prices fluctuate on a daily basis so the spread constantly changes.

Ten-year Treasuries are debt instruments regularly sold by the federal government. The government uses bond proceeds to pay for federal expenses and uses money raised from taxes to pay interest to the bond holders. After 10 years, the bonds reach maturity and the bond holders receive a return of premium. Bond holders can hold the debt until maturity or sell the bonds to other investors during the bond term. When bonds are sold, the investor must agree to a sale price with the buyer and may receive a premium for the bond or sell it at a discount.

When you take out a 30-year mortgage, your lender typically sells the debt to a mortgage investment firm. Mortgage investment companies package mortgages with similar interest rates into mortgage funds and then sell bonds tied to these funds as securities. Since most 30-year mortgages are paid off or refinanced within 10 years, bonds tied to 30-year mortgages are often compared to 10-year Treasuries, as both investments are types of debt instruments.

Investors perceive the federal government as a low-risk borrower since the government has the ability to raise taxes to cover cash shortfalls and the ability to cut its expenses. Therefore, the government pays less to borrow money than the average consumer because the consumer could easily run into financial problems due to a job loss or ill health. Bond holders are creditors and charge interest rates based on risk. Consequently, mortgage holders pay more to borrow money than the federal government, which means the spread between the 10-year Treasury and a 30-year mortgage seldom drops below 1.5 percent.

The spread between the 10-year Treasury rate and the average 30-year mortgage rate grows during recessions when large numbers of borrowers default on mortgage payments. Conversely, the spread can narrow when Treasury rates are very low and investors willingly take on the added risk posed by mortgage-backed bonds in pursuit of marginally higher returns. Rates on 15-year mortgages are typically lower than 30-year mortgage rates but higher than 10-year Treasuries.