How Do Mortgage Rates Work?
You may be wondering how mortgage rates are decided. Obviously, you want to make sure
that you get the lowest rate possible, but how are mortgage rates determined, and what can you
do to make sure you have a low rate?
There are several outside factors that affect how mortgage rates are determined as we have
seen over the past few months. However, there are your own personal factors that can have a
significant impact on not only rates but the cost of your loan and maybe even impact if you can
qualify. The better your personal or qualifying factors, the better the interest rate you can get.
Mortgage rates are affected by the overall economy. When the economic outlook is good, rates
tend to increase, and rates fall when the outlook is not so great. Mortgage rates are determined
by many elements, including the inflation rate, the pace of job creation, and whether the
economy is growing or shrinking.
The Federal Reserve doesn’t set mortgage rates, but it does affect mortgage rates indirectly.
The Fed controls short–term interest rates by increasing the overnight rate that banks can
charge each other for holding funds or decreasing them based on the state of the economy.
While mortgage rates aren’t directly tied to the Fed rates, when the Fed rate changes, the prime
rate for mortgages usually follows suit shortly afterward.
The Federal Reserve controls short–term interest rates to control the money supply. When the
economy is struggling, as has been the case during COVID–19, the Fed lowers rates. These are
not the rates given to consumers, but the rates at which banks can borrow money to lend to
When the Fed decides they need to tighten up the money supply, they raise the Fed rate. While
this doesn’t directly increase mortgage rates, eventually, this filters through to mortgage rates
One more detail. Mortgage rates are directly tied to mortgage–backed securities which are
traded every day in the financial markets. Rates do change up and down daily (and sometimes
hourly) based on the sale of these bonds.
It is important to be connected with a loan officer that understands how the market works and
can provide guidance as to when to lock a loan and the best strategy for your transaction.
Which Personal Factors Affect Your Mortgage Rate?
You certainly cannot control the economic factors of mortgage rates, but you can most definitely
control your own personal factors. Let’s dive into what you can do to get the best mortgage rate
possible, beginning with your credit score.
A high credit score means you’re less of a risk to lenders. A high credit score shows that you
pay your bills on time and don’t overextend your credit. When lenders pull your credit, they see
you as a responsible borrower with a low risk of default.
This leads lenders to give you a better interest rate because you are less of a risk.
When you have a low credit score, lenders often change the interest rate significantly because
you’re at a higher risk of default for the mortgage you are getting. A low credit score indicates
that you may not pay your bills on time or that you have overextended yourself.
Taking steps to check and improve your credit will put you in a better position to get a lower
rate. Maximizing your credit score or improving a bad credit score is a whole different video and
is not something you should do on your own and I wouldn’t recommend so–called debt
consolidation providers. You can give us a call as a start.
A loan–to–value (LTV) ratio compares the amount of a loan you’re hoping to borrow against the
appraised value of the property you want to buy. The less money you put down on the home,
the higher your LTV becomes, which is a higher risk for the lender.
When you put little money of your own into the home, you have less incentive to keep paying
the mortgage when times get tough. If you have your own money invested, though, you’re more
likely to do what’s necessary to make good on the debt.
Lenders charge higher interest rates when there is a higher risk, which means if you put more
money down you have more to lose. Another factor lenders will look at when raising your risk is
how you intend to occupy the house.
Lenders like it when the property is your primary residence, which means that you will be living
there. Interest rates are usually lowest on primary residences because it’s where you live.
You’re more likely to make your payments on time because you don’t want to lose your home
Interest rates are higher on a second home, or vacation property and even higher if the home is
an investment property that you will rent out to others.
If you have a second home or investment property and you have financial issues, you’re more
likely to default on the mortgage, putting the lender at risk.
The Bottom Line
The bottom line is that both market and personal factors affect your mortgage rate. While you
can’t do anything about market conditions, you can control your personal factors. Improving
your credit score and saving for a larger down payment are two of the best ways to improve
your chances of securing the best mortgage rates.
Be sure to take care of what you can control about mortgage rates by looking closely at your
personal factors and making them as good as possible to ensure you get the best interest rates
available when applying for a mortgage. Always be sure to work with a licensed mortgage
professional and get your questions answered.
If you or someone you know is looking to buy or refinance or just get your questions answered,
please contact me at the contact information below. I look forward to helping you get into the
house of your dreams!