The Mechanics Of Mortgage Rate Movements: What Causes Rates To Rise And Fall
In normal times, mortgage interest rates depend a great deal on the expectations of investors.
Good economic news tends to be bad for interest rates because an active economy raises concerns about inflation.
Inflation causes fixedincome investments like bonds to lose value, and that causes their yields to increase.
For example, suppose that two years ago, you bought a $1,000 bond paying 5% interest each year. .
- Your interest rate: $50 annual interest / $1,000 = 5.0%
When mortgage rates fall
Thats a pretty good rate today, so lots of investors want to buy it from you.
You can sell your $1,000 bond for $1,200. The buyer gets the same $50 a year in interest that you were getting. Its still 5% of the $1,000 coupon. However, because he paid more for the bond, his return is lower.
- Your buyers interest rate: $50 annual interest / $1,200 = 4.2%
The buyer gets an interest rate, or yield, of only 4.2%. And thats why, when demand for bonds increases and bond prices go up, interest rates go down.
When mortgage rates rise
However, when the economy heats up, the potential for inflation makes bonds less appealing. With fewer people wanting to buy bonds, their prices decrease, and then interest rates go up.
Imagine that you have your $1,000 bond, but you cant sell it for $1,000 because unemployment has dropped and stock prices are soaring. You end up getting $700. The buyer gets the same $50 a year in interest, but the yield looks like this:
- $50 annual interest / $700 = 7.1%
How You Influence Your Own Mortgage Rate
Lenders offer widely different rates to different applicants.
Youll also find that various lenders will offer you different rates even though you give them all the same information.
The reason is that lenders evaluate borrowers according to their own standards. Based on each lenders formula, they might label you as a safer or riskier borrower, and theyll adjust your rate accordingly.
Lenders employ three main criteria when deciding the rate youll be offered:
If youve time, you can make all three of those better. You can work on your credit score, save a bigger down payment and pay down some debt.
Of course, its tough to do all three of those at once. And nobody expects miracles. But even just tweaking one, two, or all of those can earn you a lower rate and monthly payment.
The other way you affect your mortgage rate
Speaking of lower rates and monthly payments, your willingness to comparison shop for your best mortgage deal makes a big difference.
The CFPB report goes on:
Interest And Other Loan Charges
Interest is only one component of the cost of a mortgage to the borrower. They also pay two kinds of upfront fees, one stated in dollars that cover the costs of specific services such as title insurance, and one stated as a percent of the loan amount which is called points. And borrowers with small down payments also must pay a mortgage insurance premium which is paid over time as a component of the monthly mortgage payment.
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Health Of The Economy
Mortgage rates vary based on how the economy is doing today and its outlook. When the economy is doing well meaning unemployment rates are low and spending is high mortgage rates increase. When the economy isn’t doing as well , including high unemployment rates and a lower demand for oil, mortgage rates fall.
What Are Today’s Mortgage Rates
You can see Guaranteed Rate’s mortgage rates today up above, but if this is your first home buying experience, you might have more basic questions. Like “what is a mortgage rate” and “what do today’s mortgage rates mean for you?” Every mortgage comes with the expectation that the amount borrowed will eventually be paid back in full. However, borrowing that much money comes with a cost, and simply paying off the principal loan wont erase your debt.
Just like any other business, lenders need to make a profit on the products they offer, like mortgages and personal loans. Thats why loans almost always come with the added stipulation of interest payments, which act as the cost of borrowing money.
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Shop For The Right Lender
While lenders usually adjust their rates based on the Fed, not every lender charges the same interest rate.
- Commercial banks: These are the most common types of banks youll see. Their size means they can offer a lot in the way of convenience.
- Community banks: Community banks are also commercial banks, but they are smaller and more tied to the local economy. Community banks tend to be more in tune with the needs of their local community and can offer competitive rates.
- These banks are nonprofit organizations, which means they can offer competitive rates. Some credit unions are available to anyone in the area, while others are limited to a certain group, such as labor union members or employees who work for a specific employer.
- Online lenders: Some lenders do everything online. They may be able to offer lower rates because they dont have to cover the cost of brick-and-mortar branches.
Shopping around for lenders can make a big difference in your interest rate. And if youre not sure where to start, a mortgage broker can help you compare and identify lenders.
When youre looking at loan offers, make sure you look at the annual percentage rate and your Loan Estimate form. The APR and the Loan Estimate can give you the information you need to perform a true side-by-side comparison of the real costs of your loan.
Your annual percentage rate reflects the real cost of borrowing. Its the interest rate plus any fees associated with a loan.
The Rate Of Economic Growth
Economic growth indicators, such as gross domestic product and the employment rate, influence mortgage rates. With economic growth comes higher wages and greater consumer spending, including consumers seeking mortgage loans for home purchases. That’s good for a country’s economy, but the upswing in the overall demand for mortgages tends to propel mortgage rates higher. The reason: lenders only have so much capital to lend.
In a slowing economy, the opposite occurs. Employment and wages decline, leading to decreased demand for home loans, which puts downward pressure on the interest rates offered by mortgage lenders.
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What Are Points On A Mortgage
Discount points are a way for borrowers to reduce the interest rate they will pay on a mortgage. By buying points, youre basically prepaying some of the interest the bank charges on the loan. In return for prepaying, you get a lower interest rate which can lead to a lower monthly payment and savings on the overall cost of the loan over its full term.
A mortgage discount point normally costs 1% of your loan amount and could shave up to 0.25 percentage points off your interest rate. The exact reduction varies by lender. Always check with the lender to see how much of a reduction each point will make.
Discount points only pay off if you keep the home long enough. Selling the home or refinancing the mortgage before you break even would short circuit the discount point strategy.
In some cases, it makes more sense to put extra cash toward your down payment instead of discount points If a larger down payment could help you avoid paying PMI premiums, for example.
Calculating A Mortgage Rate
Interest rates on home loans are built up using an index based on the current market, such as the bond market, and a markup that represents the lender’s profit. If you’re looking at published rates, note that they tend to represent an average, and you may find that rates in your specific geographical area vary.
The rates you’re offered will also be impacted by your credit score range. Lenders price your mortgage loan based on your risk profile.
If you have a great credit score, it’s much less likely statistically that you’ll default on your loan, so you’ll get a lower interest rate. If you have a lower credit score, your lender will want more interest to compensate for the additional risk of you defaulting on the loan, so you’ll have to pay a higher interest rate. Use the mortgage rate calculator below to get a sense of what your monthly payment could end up being.
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How Occupancy Affects Mortgage Rates
Another factor that really plays into your mortgage rate is how you plan to occupy the property. Is it a primary home, second or vacation home, or an investment property?
You get the lowest rate on a primary property, while rates may be slightly higher for a vacation home and slightly higher again for an investment property. This again goes back to risk.
If you get into financial trouble, youre going to make the payment on your primary property before you would make one on your second home. Similarly, you may make the payments on your vacation home before you make it on a rental property that you dont live in and have an attachment to beyond collecting rent.
How You Can Get Ready To Purchase A Home
Saving for a down payment on a home and improving your credit score are both long-term personal finance goals, but you can still take steps to get started today.
First, consider using a , like Experian or IdentityForce. Many of these services are offered for free by multiple financial institutions, and can help you understand the factors that affect your credit score. And if you see something that may be incorrect or negatively affecting your score, you can take a proactive approach to fix those issues.
In addition, you may want to sign up for a high-yield savings account to put away money for a down payment. While interest rates on these accounts remain low, every dollar you can earn in interest will bring you closer to your goal of buying a home. It isn’t advisable to keep your money in a checking account as there is basically no interest accruing, and investing the money is likely too risky as you don’t want market volatility to affect the ability to buy a house. However, some robo-advisors, like Wealthfront, will create a lower-risk portfolio for you based on when you want to buy a home.
Finally, consider establishing a budget for yourself. It isn’t an exciting task, but it’s a foundational part of your financial journey to purchasing a home. By building a budget which factors in how much you can save each month for a home, you can begin projecting when you’ll have enough funds for a down payment.
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Mortgage Rates Are Offered In Eighths
- Mortgage rates are generally offered in eighths
- If its not a whole number like 4% or 5%
- Expect something like 4.125% or 5.25%
- Or a promotional rate ending in .99%
One thing Id like to point out first is that mortgage interest rates move in eighths.
In other words, when youre ultimately offered a rate, it will either be a whole number, such as 5%, or 5.125%, 5.25%, 5.375%, 5.5%, 5.625%, 5.75%, or 5.875%. The next stop after that is 6%, then the process repeats itself.
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Fixed Versus Adjustable Interest Rates
A mortgage on which the interest rate is set for the life of the loan is called a fixed-rate mortgage or FRM, while a mortgage on which the rate can change is an adjustable rate mortgage or ARM. ARMs always have a fixed rate period at the beginning, which can range from 6 months to 10 years. The rate adjustment feature of an ARM makes it a lot more complicated than an FRM, which is why many borrowers wont consider an ARM.
Mortgage Rate Forecast For 2022 And 2023
Wondering if mortgage rates are going up or down in 2022 and the year after? Wonder no longer.
The following table provides 2022 mortgage rate predictions for the 30-year fixed from well-known groups in the industry, along with a 2022 estimate.
Take them with a grain of salt because theyre not necessarily accurate, just forecasts for future rate movement.
|Mortgage Rate Predictions|
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How Do Those Factors Translate Into Mortgage Rate
The lower the DTI, the lower the risk for the investor and lower the mortgage rate hell ask you to pay.
Same applies for LTV. If your loan amount is small compared to the value of the home, the lenders risk is lowered and youll get a better rate.
Higher FICO scores lead to the same outcome. You have demonstrated a good history of paying back your debt. The lender will see you as less risk and offer you a lower rate.
Remember, a lower DTI, a lower LTV and a higher FICO score will get you the lowest rate. That is what you have to aim for.
Shop Around For Lenders
Each mortgage lender will charge you a different mortgage rate, so comparing lenders will help you get the best deal.
You can apply for prequalification with multiple lenders to compare rates. When you apply for prequalification, a lender looks at your finances and gives you a general idea of what you’ll pay.
You could also apply for preapproval with lenders if you know you want to buy soon. This is a more formal process that requires a hard credit inquiry, but it shows you the exact rate a lender will charge. It will also lock in your rate, usually for 60 to 90 days.
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Is There Anything Else That Lenders See As Risk
There is one more risk that the lenders end up facing. The risk of you prepaying the loan.
What? Why is that a risk? As a lender, wouldnt I be happy if the money is paid back in full and before time? In full, yes. All lenders love that. But before time, not really.
Banks and other lenders are in the business of making loans. The original principal is what they owe to depositors. Their revenue solely comes from the interest you pay them. If you pay back early, they will not be earning interest from you any more.
One would ask, well they can make a new loan and start earning interest again. A very fair point.
Unfortunately, people prepay and refinance their loan only when interest rates go down. For a bank to be paid the loan amount in full is bad because the new loan the bank will make will be at a lower rate than what you were paying him so far.
This type of risk is called reinvestment risk. Because most mortgages in the US dont have a prepayment penalty associated with them, people can refinance whenever rates fall. So lenders face that risk. Unfortunately, no one refinances when rates go up to make it even for the lenders.
That risk is not with specific borrowers only. Its a risk they face with all borrowers in general. If borrowers were prohibited from early payment, all of us would have had slightly lower mortgage rates. But most borrowers are fine to have the option to prepay for a small cost in the form of a slightly higher mortgage rate.
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