How are Mortgage Rates Determined?

When mortgage rates are in the news, it's usually because “rates are going up” or “mortgage rates are at all-time lows”. What makes changes in mortgage rates newsworthy?

The Big Picture

Mortgage rates vary from day to day, lender to lender, and borrower to borrower. In general, the overall mortgage rate environment is determined by several factors, over which the homebuyer has little or no control.

Day to Day Mortgage Rate Changes

Like other financial products, mortgage rates are largely dependent on economic factors.

Unemployment, inflation, housing, the stock market, etc. all contribute to what happens with mortgage rates. How each affects the mortgage environment is nuanced and beyond the scope of a simple blog post, but the general rule is when the economy is doing well, rates tend to  rise. When the economy is slowing or needs a boost, mortgage rates tend to improve.

Like the stock market, the mortgage rate market fluctuates from day to day.

Rates move up and down, often in increments that don’t necessarily impact the interest rate on new mortgages. More so, these fluctuations affect the lender’s revenue when offering a specific loan rate to a homebuyer. Sometimes economic forces are such that mortgage rates will adjust midday. When these fluctuations are great enough, lenders will adjust the rate offered to the consumer.

Since how you behave financially in the days prior to applying for a mortgage has no effect on the U.S. macroeconomy and the factors that dictate day to day mortgage rates, it makes sense to focus your efforts on actions that you can take to improve your mortgage rate.

Mortgage Rates Vary from Lender to Lender

Not all lenders offer the same mortgage rates. Some lenders may specialize in a certain type of loan or be better equipped to handle a specific loan program. Therefore, while most lenders aren’t going to turn away business, they may have above market rates on certain loans if those loans avert resources away from areas in which they specialize.

For example, a lender whose office is geared towards processing conventional mortgage loans might have better conventional loan rates than a comparable FHA or VA loan. Conversely, there are several lenders whose expertise in FHA and VA loans permit them to offer better rates on those programs than others.

When you shop around for mortgage rates, you improve your chances of obtaining a mortgage with more favorable terms.

Borrower Specific Mortgage Rate Adjustments

The last piece of the mortgage rate puzzle is you, the borrower. Banks lend out money, a mortgage loan, with the assumption you’ll pay them back.

That assumption is determined by assessing the risk you pose to their bottom line. If your application is strong, the risk they’re assuming is lower, and the more likely you are to be offered their best terms. The strength of your mortgage application will save you money.

Down Payment

The more of your own money you put into the purchase of a new home, the less risky your loan is to your lender. Most mortgage lenders will charge an interest rate premium if you make a down payment that’s less than 20%. Borrowers are less likely to default on loans with larger down payments. The reduced risk results in a lower mortgage rate.

Although FHA, VA, and USDA loans have low down payment requirements, these loans have competitive interest rates because they are backed by the respective government department underwriting them. Government backing reduces risk in a similar way as a larger down payment. Thus FHA, VA, and USDA are almost always worth exploring.

Credit Score

Your credit score is always a factor. Nearly every lender has minimum credit score requirements, even if the loan program itself does not. Unfortunately for lower credit score buyers, the credit score you bring to the table at the time of application will impact the interest rate you’ll ultimately pay. If your credit score is over 740, you’re in good shape.

If you aren’t in that upper tier of 740+, you aren’t alone. Most lenders have a minimum credit score of 620. The closer you are to their floor, the higher your rate will likely be.

Less Likely Scenarios that Impact Mortgage Rates

If you are buying a second home or a house to rent out as an investment, you will likely pay a higher rate than if the home were to become your primary residence. Refinance rates may also differ from rates offered to homebuyers.

Summary

Mortgage rates change daily due to factors beyond your control. Taking great care with your credit and saving for a larger down payment are the primary ways in which you can ensure favorable mortgage rates.