How are mortgage interest rates determined?

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The cost of almost everything is increasing these days – and if you’re in the market for a home, you’ve probably noticed that this includes mortgage rates.

Mortgage rates are averaging about 5.9% nationwide, and they’re likely to rise again. That’s because the US Federal Reserve made the biggest rate hike in almost 30 years to fight inflation.

However, the Fed’s interest rate isn’t the only thing that determines your mortgage rate. It has an impact, but so do many other factors — like the general state of the economy or the type of mortgage you have — as well as your personal financial profile.

Here’s everything you need to know about how mortgage rates are determined and how it affects your home purchase.

Factors affecting mortgage rates

Most of the factors affecting mortgage rates are beyond your control: Greater forces are at work in the economy and in the country’s major financial markets. There is some Factors in your control – like creditworthiness or loan-to-value ratios – and we’ll get to that later. But first it is important to understand the larger forces at work.

The Federal Reserve and the federal funds rate

You’ve probably heard a lot about that lately. There are two reasons for this: First, because the key interest rate is rising. And second, because it’s one of the more important factors behind mortgage rates.

“The Federal Reserve controls the federal funds rate, and the federal funds rate is basically the rate that banks lend to each other. And if the cost of capital goes up and they raise interest rates, the interest that the consumer will get will be correspondingly higher,” he said Mayer Dallal, Managing Director at the digital construction finance provider MBANC.

Essentially, the money that banks borrow costs money in the first place, and they then need to make a profit when they lend the money to a homebuyer. So if the Fed raises interest rates, banks will raise mortgage rates to keep their profit margins intact.

The bond market

A bond is a type of loan, typically used by corporations and governments, with a strict repayment schedule by its maturity. Historically, the bond market has been fairly stable and predictable. But as inflation rises, the long-term value of mortgage bonds falls, Dallal said.

That affects mortgage rates because they usually do the opposite what the bond market is doing. So when bond prices fall, mortgage rates rise.

Mortgage-Backed Securities

Mortgage-backed securities, or MBS, are similar to bonds. But unlike a traditional bond, repayments to investors come from all of the mortgages backing the bond. An example of this would be institutions such as Fannie Mae or Freddie Macwho buy loans from lenders and structure them to pay interest like a bond, but in a mortgage-backed security.

Mortgage lenders generally raise interest rates when the prices of mortgage-backed securities fall. And lenders lower interest rates as the price of MBS rises.


The relationship between inflation and mortgage rates is fairly simple: as the cost of goods and services increases, mortgage rates rise to keep up. Also, institutions like the Federal Reserve have an interest in cooling inflation, and they often raise interest rates to slow the economy (ideally without plunging it into recession).

“When the cost of things goes up, the only way to really contain inflation is to raise interest rates,” Dallal said.

state of the economy as a whole

It’s hard to describe the overall state of the economy when talking about a country as large and diverse as the US. But the general feeling of how the American economy is doing is ultimately affecting interest rates.

For example: In the early days of the COVID-19 pandemic, American economies were bad almost everywhere. As a result, interest rates stayed low to encourage people to borrow and spend despite the harsh market conditions. Now it’s the other way around: the economy (and the housing market) is overheating, and interest rates have risen to try to cool things down.

Secured overnight rates (SOFR)

This is a different way Banks lend each other money, but refers specifically to overnight borrowing. The SOFR was consistently low throughout the pandemic but increased significantly from April.

Just like the prime rate, this is a base factor that affects the banks’ bottom line and ultimately the mortgage rates they are able to offer. “If their funding costs go up, it will be passed on,” Dallal said.

The Treasury interest rate with constant maturity

The Constant Maturity Treasury Rate is a daily measure of Treasury security returns seen as a predictor future funding costs (again, the cost for banks to raise funds in the first place). It is an important indicator for lenders who use it frequently to calculate annual rates that affect the variable interest rate on adjustable rate mortgages (ARM loans).

type of mortgage

At the end of the day, mortgage rates are about risk. Banks use mortgage rates to make a profit, but also to protect themselves in the event a borrower defaults on a loan.

Because different types of mortgages have different levels of risk, mortgage rates will vary accordingly. For example, a mortgage for a single-family home is usually cheaper than a mortgage for an apartment building. A shorter-term mortgage, like 15 years, is also less risky and would likely have a lower interest rate than a 30-year mortgage.

“If it’s a shorter period, you get a better price,” he said Meghan Jones-RollaChief Legal Officer and Chief Operating Officer at Mortgage Connect, a mortgage services company.

What affects my personal mortgage rates?

When you combine all the macroeconomic factors, you end up with a standard interest rate that a bank advertises on its website. But that’s not necessarily the interest rate you end up getting. It may increase (or decrease) depending on your financial situation and the specifics of your mortgage.

pro tip

The mortgage rate that a bank advertises online may not be what you end up getting. Talk to a lender to find out what type of interest rate you qualify for.

Loan to Value Ratio

Simply put, the loan-to-value ratio, or LTV, is the relationship between the value of a home and the size of the mortgage. For example, if you have a 20% down payment, that means your mortgage covers 80% of the home’s value and your LTV is 80%.

This affects mortgage rates because a higher LTV is seen as “more risky” for a bank – you have less equity in your home and there is a greater risk that the bank will lose money if you default on your loan . Banks and lenders compensate by raising mortgage rates when the LTV is higher.

“The higher the loan-to-value, the higher the interest rate, and that’s purely based on a risk assessment,” Dallal said.

Personal Credit Profile

When a bank grants you a mortgage, they want to be sure that you can make the payments reliably. Having a strong credit profile and score gives a bank more confidence. As a result, lenders are usually willing to offer you a lower interest rate if you have a strong credit profile.

“Today, credit is more important than ever,” said Dallal.

down payment

This ties in with the concept of the loan-to-value ratio. Paying a larger down payment means your loan will cover a smaller percentage of the home’s value. In effect, this means that it is less risky for a bank to offer the loan and they may offer a lower interest rate.

On the other hand, a lower down payment is considered more risky and a lender might increase the interest rate accordingly to compensate. Typically, a down payment of less than 20% would result in the need for private mortgage insurance for the same reason.

Can I get a lower rate than the national average mortgage rate?

When you read about rising mortgage rates, you often read about the national average mortgage rate. That’s a number determined by weekly rate information that lenders make available to the public, and represents the “typical” mortgage rate when you average out all the variations.

Many homebuyers wonder if they can beat that rate to get a better deal on their mortgage. Experts say it’s possible, but it depends on a few factors.

First, you need an excellent credit profile if you think you’re going to get a below-average interest rate. Second, it depends on the specific lending services; Some lenders offer artificially low interest rates when they want to expand their mortgage portfolio just to increase volume, Dallal says. And third, you may be able to get a lower interest rate if you consider rebate points, or mortgage points, which are an additional fee you pay upfront when you buy a home in exchange for a lower interest rate over the life of your mortgage to buy.

However, Dallal warns that a lower rate is not always better. There are other factors to consider when choosing a lender. You want to make sure you are working with someone you trust who can complete your home purchase on time.

“The best price doesn’t always reflect the best circumstances,” Dallal said. It’s just as important to pay attention to the closing cost as the rate. Closing costs are the additional fees that make up the cost of borrowing. Some lenders offer a higher interest rate in exchange for lenders. When comparing loan offers, don’t count all candidates by interest rate alone. Ask about all rental fees.

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