An Overview Of How Mortgage Interest Rates Are Determined

Several factors affect how mortgage rates are determined today, but you can only control one aspect: the personal factors. Lenders look at your qualifying factors to determine your risk level. The better your qualifying factors, the better the interest rate they’ll offer.

 But it all starts with the current market rates, so you may wonder how the market affects interest rates.

 Mortgage rates are affected by the overall economy. When the economic outlook is good, rates tend to increase, and rates fall when they’re not so great. It seems somewhat backward, but here’s the reasoning.

 When the economy is doing well, borrowers can afford more. Without increased rates, the demand for mortgages could exceed the bandwidth of most lenders. Slightly rising rates keep everyone on the same level.

Conversely, when the economy declines and unemployment rates increase, interest rates fall to make it more affordable for borrowers to take out loans.

Frequency Of Interest Rate Changes

Every day, banks receive rate sheets. This doesn’t mean rates change daily, but they can. In fact, they can change multiple times a day.

Which Market Factors Affect Mortgage Rates?

Market factors are some of the largest driving forces behind mortgage rates. The Federal Reserve, bond market, Secured Overnight Finance Rates, Constant Maturity Treasury, the health of the economy and inflation all affect mortgage rates.

Federal Reserve

Many people assume the Federal Reserve sets mortgage rates. They don’t, but the Federal Reserve does affect rates. The Fed controls short-term interest rates by increasing them 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, which is why you’ve likely heard rates are close to 0%. These are not the rates given to consumers, but the rates at which banks can borrow money to lend to consumers.

 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, banks and lenders must follow suit to keep up with their costs to borrow money from the Fed.

Bond Market

Mortgage rates have a reputation of being tied to the 10-year Treasury note when they’re tied to the bond market.

 Mortgage-backed securities, or mortgage bonds, are bundles of mortgages sold in the bond market. Bonds affect mortgage rates depending on their demand. When the demand for mortgage bonds is high (usually when the stock market performs poorly), mortgage rates increase, and when the demand is low, mortgage rates decrease.

Secured Overnight Finance Rate

A secured Overnight Finance Rate (SOFR) is an interest rate set based on the cost of overnight borrowing for banks. It’s often used by lenders to determine a mortgage’s base interest rate, depending on the type of home loan. It’s grown in popularity to serve as the replacement for the London Interbank Offer Rate (LIBOR), which is being phased out at the end of 2021.