How Interest Rates Affect Your Mortgage

Mortgage interest rates are something every homebuyer must think of when looking to obtain financing. Too often, consumers find themselves focusing on rates and nothing else. Well, what is a mortgage rate? A mortgage rate or interest rate is the amount of interest you will pay the bank on borrowed money in a form of a percentage. A mortgage interest rate is one of many components that is used in calculating a monthly mortgage payment. In many cases, it could be the biggest portion of your payment, so doing your homework is always a good idea. Let’s take a deeper look into what that really means to you and how it will affect your payment over your loan term.

Where does the lender obtain the rate?

Interest rates are determined on a daily basis and sometimes will fluctuate throughout the day (based on market conditions). What market you ask? The Mortgage Backed Securities market(MBS). The MBS trades mortgage bonds. A mortgage bond is a bond backed by a pool of mortgages on a real estate asset such as a house. These mortgage bonds pay out interest and based on the rate of interest, mortgage interest rates are calculated. Why the constant change in the rates throughout the day?  Most lenders will price-in with an assumption of some movement up or down in the bonds market, in order to avoid frequent mortgage interest rate changes throughout the day.

What determines a mortgage interest rate?

Contrary to popular belief, the lender or the bank has almost nothing to do with what rate you qualify for. The key component of determining or qualifying for an interest rate is based on four factors:

  • Credit scores (the middle of the three scores)
  • Type of program (Conventional or FHA, Conforming or Non-conforming, Fixed or an ARM)
  • Loan term (30 year, 15 year, 10 year etc.)
  • Amount of equity or down payment

When you can provide the lender those particular factors, the lender is able to more accurately quote you the rate and set proper expectations. After all, the higher the interest rate the higher the payment and vice versa. Too often, borrowers will call around and ask each lender what rate they are offering that day. You’re setting yourself up for a disappointment. You should try and provide as accurate information as possible to have a better overall buying or refinancing experience.

What can affect the MBS market and rates?

There are a few factors that contribute to market changes.  Many of the same things that affect the stock and bond market will affect the mortgage market. Here are a few of those factors:

  • The Federal Reserve is tasked with keeping balance between inflation and the national unemployment rate. One of the ways it influences this balance is with its federal funds rate – the interest rate that banks charge each other for short term loans or overnight loans.
  • Competition. There is some element of rate change connected with how many potential borrowers are requesting loans. If there are fewer borrowers in a certain area, lenders will have to compete harder for that business and are more likely to lower their interest rates. And the opposite is true if a market is saturated with borrowers looking to buy and refinance.
  • The secondary market. Because most home loans are packaged together and sold to investors as mortgage-backed securities on the secondary market, any changes in supply and demand can also influence the direction of mortgage interest rates. If investors get spooked, they often rush to the safety of bonds, which can push mortgage rates lower.
  • The overall state of the economy also has an effect on the mortgage market and its rates. When the economy is growing, mortgage rates often rise as well to keep pace with inflation and the volume of home loan applications, but fall when the economy is suffering.
  • Global economy. Beyond all the domestic financial variables that determine mortgage interest rates, they are also influenced by global concerns. Around the world, things like political instability, financial crises, increased foreign economic competition, changes in fuel costs and altered trade agreements can all play a role in whether mortgage interest rates rise or fall.

As a consumer looking to obtain a loan for refinancing or purchasing a home, there is some homework to do. Determine what type of loan and loan term suits you, know what your home is worth or if buying, how much the house is and how much you would need for the down payment, let your loan officer verify your credit score, and find the time in the market to move forward with financing and let your loan officer handle the process. Waiting for the lowest rate will not only be difficult, but it can prevent you from getting a loan that makes sense right now.

Happy homeownership!