A Boon For Banks, A Calamity For Consumers

While mortgage rates have risen sharply in recent weeks, deposit rates have stayed put. That may be a best-of-both-worlds scenario for banks, but it is precisely the opposite for consumers.

Simply put, if you compare mortgage rates with deposit rates, you'll find that the rates banks charge on loans is rising, but the rates banks pay on deposits is not. This exacerbates the rise in mortgage rates, because consumers are not getting a proportionate rise in their deposit yields.

An uneven deal

Market commentators talk in general terms about whether interest rates are rising or falling, but not all interest rates move in lockstep. As a result, fluctuations in the gap between two sets of interest rates, which is generally referred to as the "spread" between rates, can indicate as much about conditions as the direction of rates overall.

In the case of bank rates, banks make money on mortgage rates and spend money paying deposit rates. The higher the spread between mortgage rates and deposit rates, the better the profit potential is for banks -- and the worse a deal it is for consumers.

That spread between 30-year mortgage rates and one-month CD rates reached a post-recession low at the end of last year at 3.16 percent, but it had risen to 3.37 percent by May. Since then, mortgage rates have continued to rise while deposit rates have stayed put, so that spread is now around 4 percent. Considering that the historical average spread is 2.81 percent, conditions already favor banks over consumers, and that advantage is growing.

How to respond

Here are three ways the widening spread between mortgage and deposit rates may affect consumers:
  1. It pays to maximize your down payment. Even when potential home buyers have ample funds on deposit, they are understandably hesitant to pour everything into a down payment on a home because they want to keep some liquidity for emergencies. While that still makes sense, the changing numbers suggest this may be a good time to maximize your down payment as much as you can without leaving yourself completely lacking liquidity. The reason is that with mortgage rates getting more expensive while deposit rates stand pat, the cost of borrowing is rising faster than the benefit of saving.
  2. It makes sense to keep CD maturities short. Mortgage rates are rising before deposit rates because longer-term interest rates tend to be more reactive to changing conditions, and banks are protecting themselves against future rate hikes by raising mortgage rates first. This suggests that deposit rates should start to follow eventually, making this a good time to keep your CDs short and reinvest more frequently as CD rates start to rise.
  3. Shopping for rates -- whether borrowing or depositing -- is critical. When the environment for bank rates starts to change, not all banks react in the same way. This can mean greater disparities among different banks in their mortgage rates and deposit rates. To make sure you capture the best deals resulting from those disparities, you should get multiple mortgage quotes, and compare deposit rates from multiple banks.

Recent years have seen a long cycle of falling interest rates, so a rise in rates was inevitable. However, what today's relationship between mortgage and deposit rates shows is that when a change like that comes, it doesn't always happen in an orderly and uniform manner.