Mortgage Rate Influencers

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“What are today’s mortgage interest rates?” is a question I’m often asked. With a mortgage likely the largest debt a person has, the interest rate attached to that mortgage has a huge impact on the overall cost of that loan. 

Interest rate, as it pertains to mortgages, is the amount that a lender charges a borrower for taking out a loan, typically expressed as an annual percentage of the loan balance. While there are several factors within a borrower’s control that can influence the interest rates available to them, there are also many elements at play behind the scenes that also have an impact.

Factors outside our control 

The general economic outlook influences interest rates. During times of high economic growth, low unemployment, and higher inflation, mortgage rates tend to rise. When prices climb, our dollar has less buying power and lenders must charge a higher interest rate to make up the difference. The reverse is true, and rates generally fall as the unemployment rate grows, the economy slows, and inflation drops. One need only look at the current economic situation in the United States with mortgage rates at record lows to see evidence of this correlation. 

Another factor working behind the scenes to influence mortgage interest rates is the bond market. When you take out a mortgage, your lender usually sells that loan on the secondary market. This secondary market is made up of public and private investors such as Fannie Mae and Freddie Mac, both government-sponsored enterprises (GSE), as well as investment banks, pension funds, insurance companies, mutual funds, and hedge funds. The secondary market plays a crucial role for lenders; without a secondary market they would eventually run out of capital from which to lend. Mortgages are pooled and sold to these investors in the form of mortgage-backed securities (MBS) which pay interest to the investor. What is an MBS? Simply put, it’s a bond secured by mortgages, purchased by these investors. Imagine a savings bond. When you purchase a savings bond, you are loaning the government money. That bond then accrues interest over time. Once your bond reaches the end of its term, you can get your original investment back plus the interest that bond has earned.  

Bond prices and mortgage rates have an inverse relationship, and most mortgage lenders keep their interest rates slightly higher than bond interest rates. When bond interest rates are high, the bond has less value on the secondary market. This in turn causes mortgage interest rates to rise. The opposite is true when bond interest rates are low.

Factors within our control

What about the factors within our control that also affect the interest rate? Your credit score is a big player in obtaining a mortgage. Ranging between 300 and 850, credit scores of 740 or higher will generally afford the borrower the lowest interest rates available. A lower score implies more risk to the lender and borrowers with lower scores generally see higher interest rates. For scores below 620, the loan is usually insured or guaranteed by the federal government, in the form of an FHA loan. 

Another factor that influences the interest rate is the loan-to-value (LTV) ratio. If you purchase a $200,000 home and put $40,000 down, you are borrowing 80% of the home’s value and your LTV is 80%. For loans with LTV’s above 80%, interest rates can be higher, and the borrower will usually have to pay mortgage insurance. For LTV’s below 80%, the terms are generally more favorable. 

These are just the basics on some of the factors that affect interest rates. Next month we’ll take a closer look at how mortgage pricing works and what determines the interest rate that you see on your mortgage statement.   

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