What is the Velocity of Money and How Does it Impact Home Loan Rates?

By Jacquelyn Brinker

If you’ve been watching the economic news, you’ve probably noticed that reports are chock full of information on the economy. Remember the phrase, “It’s the economy, Stupid?” Market experts and traders have been keeping a close eye on the Commerce Department’s Personal Spending and Personal Income reports. Obviously, those reports provide insight into the health of our economy, but did you know they also influence home loan rates? That’s right, personal spending can actually influence the interest rates that are available when you purchase or refinance a home. Who knew?

Here’s why. It has to do with something called the velocity of money. Even though the government keeps pumping money into the system, nothing happens until that money is spent or lent – and passes from one hand to another or one business to another. The speed at which this money passes between parties is called the velocity of money.

With the job market still very sluggish, consumers aren’t spending much money these days, and businesses are still reluctant to spend money to make investments in their business. Most business owners are playing “wait and see”, and trying to preserve their assets rather than making investments in their businesses or considering expansion moves. With the present velocity at low levels, inflation remains subdued and that’s good for home loan rates. That’s because rates are tied to Mortgage Bonds and inflation is the archenemy of Bonds, so low inflation is good for Bonds and rates. However, once velocity increases, and it will, the excess money in the system will cause inflation – which is bad for rates, since even the slightest scent of inflation can cause home loan rates to worsen.

While we certainly want to see better economic recovery news and a decrease in the unemployment rate in the very near future, we have to remember that there’s an inverse relationship between good economic news and Bonds and home loan rates. Weak economic news normally causes money to flow out of Stocks and into Bonds, which helps Bonds and home loan rates improve. Strong economic news, on the other hand, normally has the opposite result.

As we’ve been saying for some time now, current home loan rates are at a historically low levels, but that situation won’t last forever. That continues to mean that now is an ideal time to purchase a home or refinance before the velocity of money – and rates – change. If you or anyone you know would like to take advantage of historically low home loan rates, then please contact my office. We are here to help as always because, Your Home Loan Matters!

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