The mortgage rate is the interest rate assigned to a home loan and is based on the price of mortgage-backed securities. The rates vary between conventional, FHA, VA, USDA, and jumbo loans; and also mortgage lender.
How Mortgage Rates Are “Made”
Huge numbers of U.S. consumers research mortgage rates every day. And most prefer to find a ballpark figure to know what buying a house would cost.
Others prefer personalized mortgage rates – especially when they’re close to making a decision about what to do next.
To everyone, though, getting a good, low rate is paramount. A mortgage is not something on which you want to overpay. Imagine paying “too much” on the most valuable asset you own; and, for the next 30 days.
In any case, it is very important to understand how the mortgage rates are set.
When you have a feel for how mortgage rates are made and how mortgage rates work, you can put yourself in a better position to shop for the lowest available rate with the best closing costs possible.
What Is A Mortgage Rate?
Did you ever wonder where mortgage rates come from?
Mortgage rates are “made” based on bonds traded in the mortgage-backed securities (MBS) market.
MBS pricing changes constantly.
In general, as the price of a mortgage-backed bond changes, so do mortgage rates. This is true for conventional mortgages backed by Fannie Mae and Freddie Mac mortgage bonds; and for FHA loans, VA loans and USDA loans, which are backed by Ginnie Mae mortgage bonds.
As is the case of almost everything else, the price of a mortgage bond is also based on the formula of supply and demand.
If all other parameters are
Mortgage rates and MBS prices move in opposite directions.
Demand for mortgage bonds can change for a multitude of reasons, but the most common driver of demand is risk-avoidance. Most mortgage-backed bonds are guaranteed by the U.S. government, therefore, they’re considered “extra safe”.
Default risk is practically nil with U.S. government-backed debt.
During periods of economic or political uncertainty, then, U.S. mortgage bonds tend to be in high demand. It’s trading pattern is known as a “flight-to-quality” and it’s a fairly common one.
When there’s a bona fide flight-to-quality going on, consumer mortgage interest tend to drop.
Mortgage rates will often move in the same direction, but not always in equal measure.
Adjustments can also be made on mortgage rates by the agency which secures the bonds.
For example, with Fannie Mae and Freddie Mac, mortgage interest rates on a 2-unit property are higher than for a single-unit home (e.g.; a detached home).
Fannie Mae and Freddie Mac also change mortgage rates for borrowers based on their credit scores. In general, the lower your credit score, the higher your mortgage rates.
These sorts of adjustments are known as “loan-level pricing adjustments”. These are like the middleman fees.
Things That Don’t Control Mortgage Rates
Mortgage rates are based on the price of mortgage-backed securities and, aside from loan-level pricing adjustments, there are no other direct forces on U.S. mortgage interest rates.
This distinction is important.
For example, here are some things that don’t control mortgage rates.
The 10-Year Treasury Note Doesn’t Control Mortgage Rates
It’s commonly said that mortgage rates follow the path of the 10-Year Treasury Note. This is not true.
The 10-Year Treasury Note is a debt-issuance from the U.S.
One of the reasons why people like to say that mortgage rates track the 10-year is because access to real-time MBS data is expensive whereas data on the 10-Year Treasury Note is as close as turning to CNBC.
For real-time mortgage rates, you’ll need to watch MBS pricing.
The Federal Reserve Doesn’t Control Mortgage Rates
The Fed Funds Rate is the overnight interest rate at which banks borrow money from each other. It’s an interest rate fixed by the Federal Reserve and used to change the speed at which the U.S. economy expands.
If the Fed Funds Rate was linked to current mortgage rates, there would be a linear relationship between the two.
Instead, the Fed Funds Rate and the conventional 30-year mortgage rate have differed by as much as 500 basis points (5.00%) over the last 10 years; and by as few as 50 basis points (0.50%) over the same period of time.
Congress Doesn’t Control Mortgage Rates
And, lastly, mortgage rates aren’t set by Congress, or any other elected U.S. official.
Mortgage rates move at random.
Getting Better at Mortgage Shopping
You have to shop “right way”.
This means remembering that shopping for a mortgage rate is really about shopping for a mortgage rate and its associated closing costs. You can’t get one without the other.
A mortgage lender will never quote you a rate without telling you the fees that go with it so pay attention when you get your quotes – a rock-bottom rate means nothing if your closing costs are astronomical.