What Determines Mortgage Interest Rates?
Several factors affect how mortgage rates are determined today, but you can only control one aspect: 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.
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. If you have your eye on an interest rate, it’s best to talk to your lender about locking the rate in quickly before it changes.
If you can afford a 15-year mortgage with its higher payment, you’ll get a lower interest rate. That’s because it costs banks more money to lend money for 30 years versus 15. If they can receive their money back in half the time, they’ll reward borrowers for it with lower interest rates. Market factors are some of the largest driving forces behind mortgage rates.
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. Mortgage rates have a reputation of being tied to the 10-year Treasury note when they’re tied to the bond market.
Mortgage rates vary based on how the economy is doing today and its outlook. When the economy is doing well-meaning unemployment rates are low and spending is high – mortgage rates increase. When the economy isn't doing as well (like during the COVID-19 pandemic), including high unemployment rates and lower demand for oil, mortgage rates fall.
Mortgage rates and inflation go hand-in-hand. When inflation increases, interest rates increase too so they can keep up with the value of the dollar. If inflation decreases, mortgage rates drop. During periods of low inflation, mortgage rates tend to stay the same or slightly fluctuate.
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