How are mortgage rates determined?
When buying a mortgage or a refinance rate, you may have noticed some strange things.
Prices can vary widely from lender to lender. Sometimes the refinancing rates differ from the purchase prices.
And mortgage rates seem much higher today than they were yesterday.
It can seem difficult to navigate the market and find a low rate when there are so many moving parts.
But with a basic understanding of how mortgage rates are determined, you can shop like a pro and save big money in the long run.
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The three factors that determine mortgage rates
There are three factors that will affect your mortgage or refinance rate.
The economyYou your mortgage lender
We will describe each of these factors in detail below. Here's a quick rundown of how all three work together to determine your mortgage rate:
The strength of the US economy sets the tone for mortgage rates. When the economy is strong, interest rates tend to go up. When it's weak, rates tend to fallIndividual factors determine whether you are on the high or low end of the mortgage rate spectrum. For example, let's say the economy is in a period of low interest rates and averages 30% for a 30 year loan. A borrower with high credit and a high down payment could be offered an interest rate closer to 2.5%, while someone with lower credit could be offered 3.5%.Lenders offer different rates to different customers, depending on what types of loans they specialize in and how much new business capacity they have. Because of this, it is important to buy mortgage rates from more than one lender
If you are currently buying mortgage or refinancing rates, this last point is probably the most important.
You cannot change the general tariff environment. And if you don't have a few months to spare, it's difficult to significantly increase your balance or save for a larger deposit.
However, you can always shop with multiple lenders.
There is probably a lower rate out there than the first one offered to you. You just have to look for it.
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How the economy affects mortgage rates
The strength of the US economy and investor confidence determine whether we are in a high or low interest rate environment at any given time. This is how it works.
Mortgage-backed securities (MBS) set the tone for mortgage rates
The first thing to realize is that most mortgages are only owned by lenders for a short time.
Soon after they close, they are usually bundled into a pile of other mortgages and sold to investors on a secondary market. This way, the lender has more money to loan to the next borrower.
Each bundle is called Mortgage-Backed Security (MBS). An MBS is a type of bond: a fixed income financial instrument that investors all over the world can buy.
How the MBS Market Affects Interest Rates
Lenders constantly monitor the secondary market on which MBS are traded.
On many days, MBS prices move hundreds of times. And when these moves are large, lenders can change their interest rates multiple times trying to keep up.
When the demand for (and therefore the price of) MBS increases, mortgage rates usually decrease.
This often happens when the economy is uncertain or in a downward trend.
These are the times when investors want to keep their money in a safe place – and MBS is generally a safe investment. This will put more money into the mortgage market and lower borrower interest rates.
For a real-world example, look at what the Federal Reserve did for mortgage rates during the coronavirus.
The Fed's New Role in Determining Mortgage Rates
After the Covid-19 pandemic hit, the Federal Reserve moved quickly to prop up markets and confidence. Much of that went into buying all types of bonds, including MBS.
Usually the Fed doesn't play a role in setting mortgage rates. Even if your own interest rates are adjusted, it does not directly affect the home loan interest rates.
This could change investor sentiment in the MBS secondary market. However, you shouldn't expect to pay less on your new mortgage just because the Fed is cutting its interest rates.
However, by buying more than $ 1 trillion in MBS, the Fed has had a direct, albeit almost invisible, impact on mortgage rates.
Such a big new buyer drives MBS prices up, lowering yields and mortgage rates.
Keep an eye on the news when you shop
So you can see that the economy is a big factor in understanding how mortgage rates are determined. When things are booming, mortgage rates are usually high. When it's in trouble they are usually low.
And that applies every day. An unexpectedly good economic report can drive mortgage rates up, while a report that is spectacularly worse than expected can drive them down.
Because of this, it is important to keep the news in mind when buying mortgage rates. You can drop anytime, and you'll want to be ready to lock when the time comes.
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How You Influence Your Own Mortgage Rate
Lenders offer very different interest rates to different applicants.
You will also find that different lenders offer you different interest rates – even though you are giving them all the same information.
The reason is that lenders rate borrowers according to their own standards. Based on each lender's formula, you may be classified as a "safer" or "riskier" borrower and your interest rate adjusted accordingly.
Lenders use three main criteria to determine the rate that will be offered to you:
Your credit score and report – Your balance sheet for managing debt in the past is the best indicator of how you will deal with this new debtYour down payment (a.k.a. "loan-to-value ratio" or "LTV") – The more money you contribute to the purchase, the less a lender can lose if something goes wrongWhat is the burden on your existing debt (a.k.a. "Debt-Income Ratio" or "DTI")? – Someone who is struggling to keep up with existing monthly payments may find a mortgage, and additional home ownership is the last straw
If you have the time, all three can be improved. You can work on your credit, save a larger down payment, and pay off debts.
Obviously, it's difficult to do all three at the same time. And nobody expects miracles. But even if you tweak just one, two, or all of them, you'll get a lower rate and monthly payment.
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The other way you affect your mortgage rate
When you talk about lower interest rates and monthly payments, your willingness to compare the best mortgage deals makes a world of difference.
As early as 2016, the federal regulator Consumer Financial Protection Bureau (CFPB) carried out a study which found that 30% of borrowers did not make comparative purchases for their mortgage. Worse, more than 75% only applied to one lender!
The CFPB report continues:
"Previous bureau research suggests that failure to compare a mortgage costs the average buyer approximately $ 300 a year and many thousands of dollars over the life of the loan."
So it's worth looking around and finding the lowest price. In fact, you can rate your shop in just a day and likely find a better deal than your first deal.
Why Lenders Offer Different Interest Rates to Different Customers
We have the key points behind our original question, "How are mortgage rates determined?" Treated.
However, this does not explain why different lenders quote the same borrower with such different interest rates. Let's do that.
Different lenders usually specialize in different categories of borrowers.
For example, some lenders could develop a niche market and offer deals to the most creditworthy borrowers. Others could help people with challenging results, maybe as low as the 500s. And some lenders specialize in certain loan programs. like self-employed mortgages or jumbo loans
If your score is 580 and you apply to a lender who specializes in higher credit borrowers, you will likely get rejected. Or you are offered a price that is too high to deter you.
The same is true if your score is 800 and you are reaching out to a lender who is used to helping those with low scores. You will likely be offered a loan but it may not come at the best possible rate for a borrower like you.
Another reason for fluctuations in lender rates
Lenders can also change their mortgage rates based on their current workload.
When loan officers and systems are overwhelmed with new loans, lenders are sometimes forced to control demand by deterring new applicants. And they do that by increasing their rates.
Lenders are unlikely to say, "We're too busy for you" or "We don't currently have enough money to give you credit."
Instead, they scare you off with worse deals. And when that doesn't work, they'll be happy to fit you in somehow and pocket the extra profit you've given them.
All of this means that even if you absolutely love your existing lender, you will have to look for your new mortgage or refinance.
Your financial situation may not have changed since you applied for your current loan, so you will be better off with another loan.
But yours may not be as competitive right now as you were when you first started.
Are mortgage rates and refinancing rates the same?
Usually mortgage and refinance rates are similar. A 30 year fixed rate loan to buy a home should therefore have a similar interest rate as a 30 year fixed rate refinance.
But sometimes mortgage and refinancing rates drift apart. And there are usually two reasons for this:
Too much demand for purchase or refinancing loans – As we noted earlier, lenders sometimes set interest rates to deter demand. And if it's refinancing that leads to excessive work (which it usually does), a lender may charge more for thoseOne is more profitable than the other – Lenders are not charities. You will seize the chance to make more profit by giving mortgages for home purchase priority over refinancing or vice versa
How often do mortgage rates change?
We mentioned earlier that MBS prices and returns can change hundreds of times in a single, busy day. This secondary market is a bit like the stock markets in that regard.
And it is true that lenders monitor changes in real time. However, they don't put out hundreds of new tariffs every day.
In fact, if things are calm in the secondary market, they may just be putting out a new interest sheet if there is one.
When things are a little more volatile in the MBS market, a lender can issue an interest sheet in the morning and afternoon. But that volatility would have to be extreme in order for you to get a lot more out of it.
The Mechanisms of Mortgage Interest Movements: What Makes Interest Rates Go Up and Down?
In normal times, mortgage rates are highly dependent on investor expectations.
Good economic news tends to be bad for interest rates, as an active economy raises concerns about inflation.
Inflation causes fixed income assets like bonds to decline in value and their returns (another way of saying interest rates) to rise.
For example, let's say you bought a $ 1,000 bond two years ago and paid 5% interest ($ 50) every year. (This is called the "Coupon Rate" or "Face Value" because you paid $ 1,000 on a $ 1,000 bond and because the interest rate is the same as the rate shown on the bond – 5% in this case).
Your Interest Rate: $ 50 APR / $ 1,000 = 5.0%
When mortgage rates fall
That's a pretty good price today, so many investors will want to buy it from you.
You can sell your $ 1,000 bond for $ 1,200. The buyer receives the same $ 50 per year in interest that you received. It's still 5% of the $ 1,000 voucher. However, since he paid more for the bond, his return is less.
Your Buyer's Interest Rate: $ 50 APR / $ 1,200 = 4.2%
The buyer receives an interest rate or a return of only 4.2%. And so, when the demand for bonds increases and bond prices rise, interest rates fall.
When mortgage rates go up
However, when the economy warms, the inflationary potential makes bonds less attractive. When fewer people want to buy bonds, their prices go down and then interest rates go up.
Imagine you have your $ 1,000 bond but you can't sell it for $ 1,000 because unemployment has fallen and stock prices are rising. You end up with $ 700. The buyer gets the same $ 50 a year in interest, but the return looks like this:
50 USD annual interest / 700 USD = 7.1%
The buyer's interest rate is now higher. Interest rates and returns are not a mystery. You calculate them using simple math.
When should you set a mortgage rate?
If mortgage rates are constantly changing, how do you know when it's time to set an interest rate?
Fortunately, it's not as difficult as it sounds.
You likely have a short window of interest buying time before it is time to freeze and resume credit.
During this time, you shouldn't expect interest rates to rise or fall too dramatically. Movements are usually small from one day to the next.
So the decision is less about the timing of your interest freeze and more about choosing the right lender.
You will likely save more on comparative purchases than you would by trying to play in the market, as even seasoned economists have difficulty predicting how mortgage rates will go.
Check your new plan (September 9, 2020)