Wednesday, September 11, 2013

How are Mortgage Interest Rates determined?

What drives mortgage interest rates?  In a very general sense, mortgage rates are determined by the overall economic environment.  Since 2008, and the Great Recession, we have seen a steady drop in the mortgage interest rates for consumers.  As the overall economy has begun to see some improvement, we have started to see those borrowing costs increase.  But what contributes to these changes?

  1. Inflationary Pressure - When inflation is likely to occur, the future value of the money that is lent now will be worth less.  Inflation, on average since the creation of the FED, is somewhere between 3%-5% per year.  The greater the rise in inflation, the higher the mortgage rates will be.  Since April of 2013, we have continued to see the inflation rate increase.  Inflation isn't bad though as it points to a healthier economy. 
  2. Bond Prices - As Bond prices drop, the rates increase and alternatively, as bond prices rise, mortgage rates decrease.  Since most loans are paid off via refinance or other method within 7-10 years, most lenders base their mortgage rates (even the 30 YR Fixed rates) on the 10 YR Treasury.  The higher the Yield the higher the mortgage rates to make the investor money (who owns the note).  We have seen yields increase from low's in April 2013 of 1.636% - since then it has raised to as high as 2.98%.  This change has increased rates from the low - mid 3% range on a 30 YR fixed to a higher rate of the upper 4% range.
  3. Employment Data, Jobs Reports, Fed Monetary Policy - As the overall economy improves mortgage rates for home loans will continue to go up as well.  Some of the key factors to watch are employment data.  How many people file for unemployment - the more unemployed the slower the economy will grow.  How many new jobs are being created - again, the more new jobs, the less unemployed and the healthier the economy.  What is the FED doing with the FED funds rate, their quantitative easing policy, etc.?  As the overnight FED funds rate stays low, rates will do the same.  If they pull bank on their bond purchases, which keeps prices up, mortgage rates will increase as well.
Mortgage rates have many varying factors as to the overall picture of average rates.  The factors not discussed are the specific client factors that impact rates.  These include credit score, down payment, type of mortgage loan, etc.  All of these will also influence mortgage rates, however, they will be in about the range of what the economy is dictating.

While this is very rudimentary, it gives an idea of what types of economic factors to watch when determining interest rates.   

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