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How Are Mortgage Interest Rates Determined

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Economic Factors That Help Determine Mortgage Rates

How Do Banks Determine Mortgage Interest Rates?

Ultimately, several factors, including the rate of inflation, the price of U.S. treasuries and the Federal Reserve, affect mortgage rates. That’s because all these things and more affect how much investors are willing to pay to invest in the mortgage-backed securities we discussed on the previous page.

Let’s start with inflation, which is the phenomenon where the prices of common goods and services rise across the board. Consistent and moderate inflation is actually a sign of a healthy economy, and should ideally result in a proportional rise in wages for workers as well. For lenders, inflation poses an inherent problem — it means that the money people borrow now will be worth less when they come to pay it back. If economists predict a rise in inflation, investors will insist on higher mortgage rates to make up for this loss.

Because investors have many choices of where to invest their money, competition among other investments also determines mortgage rates. Like with bonds and other financial instruments, investors often compare MBSs against U.S. treasuries. You might assume a 30-year fixed mortgage would compare to a 30-year treasury. But in reality, borrowers in 30-year fixed mortgages are likely to refinance or move after only 10 years. So investors compare such mortgage investments to 10-year treasuries.

We’ve just skimmed the surface of a complex system of factors that affect mortgage rates. For more on similar financial topics, explore the links on the next page.

Factors That Affect Mortgage Rates

Most of the factors that affect mortgage rates are out of your control: there are larger forces at work in the economy and in the countrys biggest financial markets. There are some factors in your control like , or loan-to-value ratios and well get to those later. But first, its important to understand the bigger forces at work.

Why Rates Vary From Borrower To Borrower

Some factors affecting your mortgage rate are under your control because rates vary based on financial situations. Your mortgage rate will partially depend on how risky the loan appears to lenders.

Lenders will review your financial history to determine the likeliness of you making payments on time, falling behind on payments or completely stopping paying on your loan. They will consider how much money they could lose if you fail to make payments.

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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.

Should I Lock My Mortgage Rate

How Are Mortgage Rates Determined?

Since your mortgage rate isnt guaranteed, it might be a good idea to lock it as soon as possible so youre not caught off guard. Make sure youve compared multiple quotes before doing so. Other scenarios in which it might be a good idea to lock your mortgage rate would be if youre closing on a home soon, you have enough assets and income to proceed with the closing process and youve already sold your current home.

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How Are Mortgage Interest Rates Determined

Like most things in this world, mortgages are not always what they seem to be on the surface instead of being a straightforward loan so that you can purchase and pay off a home, there are hidden fees in the form of mortgage interest rates. Theres nothing to fear, though: Mortgage interest rates are dependent on a whole bunch of different factors, some of which you can control and some of which you cannot. Understanding this is the key to understanding how mortgage interest rates are determined.

Get A Free Rate Quote With Total Mortgage

Overall market conditions and your personal situation are what determine interest rates. While you cant change the market, there are steps you can take to improve your creditworthiness and increase your savings to get a better mortgage interest rate.

If youre ready to apply for a purchase or refinance, you can get a free rate quote or easily apply online with Total Mortgage.

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When Should You Lock In Your Mortgage Rate

When you receive a mortgage loan offer, a lender will usually ask if you want to lock in the rate for a period of time or float the rate. If you lock it in, the rate should be preserved as long as your loan closes before the lock expires.

If you dont lock in right away, a mortgage lender might give you a period of timesuch as 30 daysto request a lock, or you might be able to wait until just before closing on the home.

Once you find a rate that is an ideal fit for your budget, its best to lock in the rate as soon as possible, especially when mortgage rates are predicted to increase. While its not certain whether a rate will go up or down between weeks, it can sometimes take several weeks to months to close your loan.

If you dont lock in your rate, rising interest rates could force you to make a higher down payment or pay points on your closing agreement in order to lower your interest rate costs.

How Treasury Investors Affect Long

Interest rates will be ‘determined by the federal election’

Rates on longer-term loans, such as 15-year and 30-year fixed-interest rate mortgages, are fixed for the loan’s term. The same is true for interest rates on non-revolving credit. These are typically consumer loans for automobiles, education, and large consumer purchases like furniture. These interest rates are usually higher than the prime rate but lower than revolving credit.

Since these loans are typically one, three, five, or 10 years, they vary along with the yields on one-year, five-year, and 10-year Treasury notes. These interest rates don’t follow the fed funds rate. Instead, they follow the yields on the 10- or 30-year Treasury Notes. The U.S. Treasury Department auctions these to the highest bidder. The yields respond to market demand. If there is a great demand for these notes, then the yields may be lower. If there isn’t much demand, then the yields need to be high to attract investors.

The chart below illustrates the fed funds rate versus the 10-year treasury from the year 2000 through today.

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How To Compare Mortgage Rates

Borrowers who comparison shop tend to get lower rates than borrowers who go with the first lender they find. You can compare rates online to get started. However, to get the most accurate quote, you can either go through a mortgage broker or apply for a mortgage through various lenders.

The advantage of going with a broker is you do less of the work and youll also get the benefit of their lender knowledge. For example, they might be able to match you with a lender whos suited for your borrowing needs, this could be anything from a low down payment mortgage to a jumbo mortgage. However, depending on the broker, you might have to pay a fee.

Applying for a mortgage on your own is straightforward and most lenders offer online applications, so you dont have to drive to an office or branch location. Additionally, applying for multiple mortgages in a short period of time wont show up on your credit report as its usually counted as one query.

Finally, when youre comparing rate quotes, be sure to look at the APR, not just the interest rate. The APR reflects the total cost of your loan on an annual basis.

What Can Cause Your Interest Rate To Change

If you get an adjustable-rate mortgage , your interest rate and monthly payment can change.

With these loans, your interest rate is set for an initial period of three, five, seven or ten years. After that runs out, your rate rises or falls based on the market index it’s tied to.

Adjustable-rate mortgage loans typically come with rate caps, limiting how much your rate can increase initially, annually and over the life of your loan. These caps can vary by lender, so it’s important to compare a few different companies if you’re considering an adjustable-rate mortgage.

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Whats The Difference Between Apr And Interest Rate

The interest rate is the cost of borrowing money whereas the APR is the yearly cost of borrowing as well as the lender fees and other expenses associated with getting a mortgage.

The APR is the total cost of your loan, which is the best number to look at when youre comparing rate quotes. Some lenders might offer a lower interest rate but their fees are higher than other lenders , so youll want to compare APR, not just the interest rate. In some cases, the fees can be high enough to cancel out the savings of a low rate.

The Factors That You Can Control

How Mortgage Rates Are Determined

Now that the factors that are out of the borrowers hands have been made clear, its worthwhile to explore the factors that you can control and discuss how they can get you a better, fairer rate in the long run.

Your Credit Score

More than anything else, a good credit score will help to secure a good mortgage interest rate. Lenders will be able to take one look at your credit score and instantly know all they need to know about you as a borrower, and this will directly influence the kind of rate you end up with. If you have a low enough score, you might not even get a chance to borrow in the first place.

Your Loan-to-Value Ratio

Just as important as a good credit score is a low loan-to-value ratio. This number tells the lender how much money the home is worth and compares it to how much money the borrower needs to pay it off. For example, if you pay off 10% of the home with your down payment, then your loan-to-value ratio would be 90%. The more you pay off, the lower that ratio will be, and the better interest rate youll end up with.

Other Key Factors

Beyond credit score and loan-to-value ratio, there are some smaller factors that rest in your hands: things like the kind of property youre buying, the level of risk associated with that property, and whether or not its going to be used as an investment for the home buyer or as a place theyll actually be living in.

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How You And Your Property Affect Mortgage Rates

  • That super low advertised mortgage rate sure looks good
  • But be sure to check out the fine print
  • You probably have to be an A+ borrower
  • And you might need to pay discount points too

Also note that the par rate you see advertised on TV and the web often dont take into account any mortgage pricing adjustments or fees that could drive your actual interest up considerably.

Generally, a lender will showcase a mortgage rate that requires perfect credit, a 20% down payment, and is only available on an owner-occupied single-family home, as seen in my fictitious mortgage rate ad illustration above.

If your down payment or credit score isnt that high, or your home equity is low, your mortgage rate may creep higher as well.

Occupancy and property type will also drive rates higher, assuming its a second home, investment property, and/or a multi-unit property. So expect to pay more if thats the case.

If you do put less than 20% down, youll also have to factor in mortgage insurance, which if not explicitly charged, is usually built into the rate.

There are also loan amount restrictionspricing can change depending on if the home loan is conforming or jumbo. Typically, monthly payments are higher on the latter, all else being equal.

In other words, YOU and your property matter as well. A lot!

If youre a risky borrower, at least in the eyes of prospective mortgage lenders, your mortgage rate may not be as low as what you see advertised.

Home Price And Loan Amount

Homebuyers can pay higher interest rates on loans that are particularly small or large. The amount youll need to borrow for your mortgage loan is the homeprice plus closing costs minus your down payment. Depending on your circumstances or mortgage loan type, your closing costs and mortgage insurance may be included in the amount of your mortgage loan, too.

If youve already started shopping for homes, you may have an idea of the price range of the home you hope to buy. If youre just getting started, real estate websites can help you get a sense of typical prices in the neighborhoods youre interested in.

Enter different home prices and down payment information into the Explore Interest Rates tool to see how it affects interest rates in your area.

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Again What Are Mortgage Rates Based On

Before you confirm your mortgage rate lock, its important to understand several market-based and personal factors have a direct impact on your mortgage rate. None of them can be removed from the process.

On the market side, the biggest direct influence is from the bond market which is where the MBS that provide the funding for residential mortgages are traded. In turn, this market is impacted by the moves of the Federal Reserve which is moved to act based on indicators in the economy overall.

Beyond movement in the market, personal financial situations play a big role. The relative levels of risk associated with mortgage-backed securities are based on factors including a persons credit score, their down payment or level of the existing equity, how they plan to occupy the property and their purpose in getting the mortgage.

Whats Behind Your Mortgage Rate

How Are Mortgage Rates Determined?

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Buying a home is probably the biggest purchase youll ever make. If youre like most people, you wont pay cashyoull borrow most of the money by taking out a mortgage. And over the life of the mortgage, youll pay a lot in interest.

Small changes in interest rates can make a big difference in how much youll pay. So its important that you understand what determines the interest rate on your mortgage, even if you already own a home.

Many factors go into the interest rate you pay.

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Fixed Payments With A Variable Interest Rate

If the interest rate goes up, more of your payment goes towards the interest, and less to the principal.

If the interest rate goes down, more of your payment goes towards to the principal. This means, you pay off your mortgage faster.

If the market interest rates increase to a certain percentage or trigger point, your lender may increase your payments. This payment increase will make sure that you pay off your mortgage by the end of the amortization period. The trigger point is listed in your mortgage contract.

Forbes Advisors Insight On The Housing Market

Predictions indicate that home prices will continue to rise and new home construction will continue to lag behind, putting buyers in tight housing situations for the foreseeable future.

To cut costs, that could mean some buyers would need to move further away from higher-priced cities into more affordable metros. For others, it could mean downsizing, or foregoing amenities or important contingencies like a home inspection. However, be careful about giving up contingencies because it could cost more in the long run if the house has major problems not fixed by the seller upon inspection.

Another important consideration in this market is determining how long you plan to stay in the home. People who are buying their forever home have less to fear if the market reverses as they can ride the wave of ups and downs. But buyers who plan on moving in a few years are in a riskier position if the market plummets. Thats why its so important to shop at the outset for a realtor and lender who are experienced housing experts in your market of interest and who you trust to give sound advice.

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When Do Mortgage Rates Change

There are several situations under which mortgage rates could change:

You pay for mortgage points at closing

Also known as discount points, mortgage points can lower your mortgage interest rate. Each point costs 1% of the mortgage loan amount.

To determine whether its worth it, divide the cost of the point by the difference from the former and new monthly payments the result is the number of months it will take for the upfront money to pay for itself. If you plan to stay in the home for significantly longer than that time period, it can make sense to buy points. If not, it might be smart to pass.

You have an adjustable-rate mortgage

A fixed-interest mortgage has a rate that does not change during the term of the loan. The static nature of the monthly payment lets you budget accordingly, with no surprises.

An adjustable-rate mortgage might be fixed initially sometimes at a rate significantly below 30-year fixed rates but will change after a certain period agreed upon in the loan document. Once the interest rate resets, the loan may become unaffordable if interest rates have gone up, especially if youve experienced a loss of income or face some other financial challenge. For that reason, these loans tend to be considered riskier than fixed loans.

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