HOW RATES ARE DETERMINED
How Are Mortgage Rates Determined?
There are many factors that determine the interest rate on your mortgage. Also understanding why rates move up and down each day is quite simple once you understand some basic economic fundamentals. The most frequently asked questions that buyers and homeowners ask are, “What’s my rate” (even before an application is filled out), or “How is my mortgage rate determined” or “why is my rate higher than what is advertised on TV?”, or “Do you see rates increasing when I am ready to buy in a few months?”, With these questions in mind, here is a guide to use that will help you better understand the different factors that will determine the interest rate on your home loan.
Your Credit Scores and Mortgage Rates
It is no secret that having good credit scores are important for buyers in this market to score the best rates and this is especially true for conventional rates. For example, a buyer with a 690 credit score purchasing a $400k home with 20% down has to pay an additional 1.5 points ($4,800) to get the same rate as a buyer with a 740 score, or, if they choose not to pay the points, instead they have to take a .375% higher interest rate (which will incorporate these points).
A buyer with a 660 score has to pay 2.5 points to get the same rate as a 740 buyer, which amounts to $10k on a $400k loan. So having good scores is important to obtain the best rates on conventional financing.
To maintain great credit, everyone should review a copy of their credit report once a year. This will ensure that you are always in a position to score the best rates when you are ready to obtain financing. As a California resident, you are entitled to a free report once a year.
Other Factors That Determine Your Mortgage Rate
There are several other factors that determine the interest rate on your loan. For example, the amount of equity you have in your home also decides what rate you get. Someone putting down 40%, or a homeowner with 40% equity in their home, will get a lower rate than someone who puts down 20%, or has 20% equity in their home, just like someone with 20% equity will get a lower rate than someone with 5% equity in their home.
The type of property you buy or own also determines the interest rate on your loan. For example, conventional financing will charge a higher rate for someone buying a condo with 20% down or less, than someone purchasing a single family residence home.
The loan amount you borrow will also effect your interest rate on your loan. Rates on loans of less than $417k, which is the conventional loan limit, will have a lower rate than a loan higher than $417k, which is considered a jumbo loan.
An investment property has a higher rate than a primary residence rate. Banks consider buying an investment property a higher risk than a primary residence, and price it accordingly. 20% is also the minimum down payment for an investment property purchase.
Borrowing cash out on your refinance will also affect your rate. For example, someone borrowing cash out to pay off some credit cards or home improvement, will usually always have a higher rate than a loan not taking any cash out.
As you can see, there are many different factors that have to be taken into consideration when determining the interest rate on your loan. There is not a one-rate-fits-all when it comes to obtaining the best interest rates on conventional financing.
What Economic Events Force Rates to Go Up or Down?
So what causes mortgage rates to go up or down? These are tied to some fundamental economic activities that take place every day in our markets, by understanding these you will now be able to better predict and understand what direction rates will probably move.
The Federal Reserve…The #1 Reason Mortgage Rates Are So Low
The Federal Reserve has been printing a lot of money over the past several years via their monetary stimulus program “Quantitative Easing”. They have been pumping this money into the markets to artificially suppress interest rates and kick-start the economy. It is fair to say it has worked as employment and housing is improving.
As you can see above, the influence of Federal Reserve stimulus on mortgage rates has been undoubted, and is the #1 reason why rates are so low in the first place. The average 30 year fixed rate prior to Federal Reserve stimulus was roughly 6.5%, compared to today’s rates below 4%.
Stocks and Bonds Compete for Investment Everyday
Stocks and Bonds compete every day for investors dollars in the open markets, stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky.
Remember: When there is weak economic news (higher unemployment, less homes sold etc.), this normally causes money to flow out of Stocks and into more stable Bonds, helping Bonds and mortgage rates improve.
But strong economic news (more employment and jobs created, more homes sold etc.) normally has the opposite result, so investors will pull their money from bonds and put it into more risky stocks, thus causing mortgage rates to increase. It is an interesting dynamic that generally good economic news is bad for mortgage rates!
The Relationship between Mortgage Bonds & Mortgage Rates
The reason that mortgage rates move up or down every day, is because Mortgage Bonds (MBS) are traded everyday just like stocks. They either go up or down in price on a daily basis.
Here is a quick synopsis of how the mortgage bond market works, so you understand how rates are determined, and so you know when to lock in your rate.
When you see these Bond prices moving higher, it means home loan rates are improving—and when they are moving lower, home loan rates are getting worse. To go one step further—a red “candle” means that MBS worsened during the day, while a green “candle” means MBS improved during the day.
Depending on how dramatic the changes were on any given day, this can cause rates to change up to 2-3 times throughout the day, as well as on the rate sheets we start with each morning. This daily trading of mortgage bonds directly correlates to the mortgage rates we see every day from lenders.
As bond markets are quite volatile these days, it is not unusual for mortgage rates to change 2 or 3 times in just one day. What this means is, the terms we quote in the morning may not be available in the afternoon if the mortgage bond market is trading negatively. This is why shopping around can hurt consumers looking for the best rates, as the rates you were quoted on one day, may not be available the next day. Please keep this in mind when reviewing rates and deciding when to lock in.
Our goal is to always ensure that our buyers and homeowners get the best possible rates available in the market. My company is approved with 47 different banks and lenders, and this includes the top 5 best rate lenders in the nation, so we will always offer the very best rates available in the market.
The Impact of Rising or Lower Rates on Your Mortgage Payments
Changing mortgage rates do more to influence home affordability than changing home prices. Now that rates are moving lower again, this is helping buyers regain some of the purchasing power that was lost recently when rates were higher.
When rates increase by just 1%, a buyer gains 10% in purchasing power or affordability, or vice versa, when rates decrease by 1%, a buyer gains 10% in purchasing power or affordability.
For example, see how the payment at the 3.5% rate on a $400k loan, is the same as the 4.5% payment on a $360k loan, which is a 10% loss in purchasing power or affordability.
A Look at Mortgage Rates over the Past 40 Years
This chart below puts current mortgage rates in perspective. Today’s mortgage rates are a gift and should be taken advantage of by anyone looking to borrow money to finance a home. The cost of borrowing money is on sale, so it is a great time to get financing to purchase a home or refinance
As you can see below, the average 30 year fixed mortgage rate over the past 40 years is roughly 8.7%, and 6.5% over the past decade. So for any buyers or people looking to refinance who are still on the fence, a rate at or below 4% is still a terrific mortgage rate.