Mortgage Rates Are Low, But Interest Rates on CDs are Lower
May 17, 2010
The theory of relativity may have been developed in the field of physics, but relativity is also a good way to look at the world of finance. For example, it's obvious that CD rates are low on an absolute basis, but looking at them relative to other interest rates helps put them into perspective. Does this relative perspective suggest that CD rates aren't so bad after all, or does it simply underscore how unnaturally low they are?
Comparing CD rates to mortgage rates adds another element to this analysis, because besides putting CD rates in perspective, it also lends some insight into bank profitability.
CD Rates and Mortgage Rates
Broadly speaking, there are two major categories of bank rates: those offered by banks as interest on deposits, and those charged as interest on loans. Banks make money off the difference, or spread, between these types of rates. This spread in rates has a significant impact on a bank's profitability.
It should also be noted that bank loans are generally longer-term commitments than bank deposits, so loan rates tend to be higher than deposit rates. (This is just like interest rates on CDs: the longer you agree to lock up your money, the higher the interest rate you demand.) Still, the question is, how does the spread between loan and deposit rates today compare with historical norms?
Historical vs. Current Spread
To look at this, MoneyRates.com used Federal Reserve data to compare 30-year mortgage rates (as a rough proxy for bank loan rates) and 1-month CD rates (as a rough proxy for not only interest rates on CDs but also short-term deposit rates on savings accounts, checking accounts, and money market accounts).
While Federal Reserve data on 1-month CD rates goes back to the end of 1965, its mortgage data only goes back to early 1971, so that's where the comparison can begin.
As of March 2010, 30-year mortgage rates were 4.78% higher than 1-month CD rates--and that's unusual. Throughout the entire data period, the average spread between these mortgage rates and CD rates was 2.72%. March's 4.78% spread was clearly on the high side. Historically, the spread between mortgage rates and CD rates had only been above 4.50% about 15% of the time. Including March, this spread had been at least that high for 14 of the last 15 months, and the spread has been above the historical average for every month from going back to November 2008.
That last date--November 2008--is probably not a coincidence. Since the financial crisis, banks and policy makers have sought to restore bank profitability by increasing the spread between mortgage rates and deposit rates. So, although mortgage rates had until recently been kept very low through massive federal stimulus, deposit rates are extraordinarily low.
CD Rates Low from Any Perspective
As a general rule, it doesn't pay to lock into long-term CD rates when bank rates are low. The difficulty sometimes is defining exactly what "low" is. However, when it comes to bank rates these days, they appear to be low on a relative and historical basis, not to mention on an absolute and inflation-adjusted basis. In short, think at least twice before committing to a long-term CD in today's economic environment.
