How are Mortgage Rates Determined?

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Zarine Torrey, Sr. Mortgage Loan Officer

Your mortgage rate is determined by a calculation that takes in many variables; some that are in your control and others that are not in your control.

Factors you control:

  • Credit score – the lowest and best rates go to consumers with credit scores of 750 or higher. The lower your score becomes, the higher of a risk for the lender to take on, so the risk is passed onto you with a higher interest rate. Lenders use your credit score to predict how reliable you will be in paying your loan. Before you start shopping for financing, check your credit score.
  • Loan-to-value ratio (LTV) – this formula measures the mortgage amount to the value of the property. The more you borrow against your home, the higher the risk for the lender, and in turn a higher rate. For example, if you buy a home for $100,000 and put 20% down, you are borrowing 80% loan-to-value. If your loan-to-value is higher than 80%, it’s more of a risk for the lender to lose money if you default on your mortgage or the home value drops.
  • Other factors – lenders will charge a higher rate for a cash-out refinance, investment properties, second homes and condominiums due to properties being a higher risk.

Factors you do not control:

  • The length of the mortgage loan – mortgage rates for a 15-year fixed-loan is quite lower than the 30-year fixed-loan. Shorter-term loans have lower interest rates and lower overall costs due to a shorter term of risk for the lender.
  • The type of mortgage loan – there are two major types of mortgage rates: fixed-rate and adjustable-rate. Fixed interest rates do not change over the term. Adjustable rates may have an initial fixed period, then after that, they will fluctuate each period based on the market. The rate can go up or go down based on the cap. Your initial interest rate may be lower with an adjustable-rate loan than a fixed-rate loan, but that rate may increase significantly later on.
  • Economy – mortgage rates tend to rise when fast economic growth, higher inflation and a low unemployment rate are predicted and expected.
  • Bond market – mortgage rates are based on the bond market. Mortgage-backed securities (MBS) drive the fluctuation in mortgage rates. Due to this, rates change daily.
  • Other factors – economic trends besides inflation and employment include retail sales, home sales, and stock prices.

Its not just one of these factors, but a combination of many that will determine your interest rate. Everyone’s situation is different, but understanding how the rates are determined will help you be more informed as you shop for a mortgage. If you have any questions, contact our team here.