Where Do Mortgage Rates Come From, Anyway?

Written by Posted On Thursday, 21 December 2023 00:00

One might wonder where mortgage rates actually come from and who makes these daily adjustments? There is indeed a method. Lenders don’t set rates pretty much out of thin air. You also might wonder why mortgage lenders from A to Z offer interest rates that look very much the same, if not exactly the same. Do they have a Zoom meeting and they all decide at once?

First, an individual lender can set interest rates based upon several factors. Rates for a  rental property will be slightly higher compared to an owner-occupied home. Rates for shorter term loans can be lower compared to a longer term loan. Rates might even adjust based upon the amount of down payment or equity in the property. Credit scores can also be a factor. Pretty much all lenders follow these guidelines.

Okay, so then why are rates pretty much the same wherever you go, with only slight variances? Because they all refer to the very same index when setting rates.

No, they’re not based upon Treasury bonds or bills, although that’s a common misconception. Close, though. Fixed rate loans refer to a similar bond. Instead, lenders look up the price of a specific Mortgage Backed Security, or MBS. An MBS is indeed a bond  that offers a fixed rate of return and just like any other bond, when the price of the bond goes up, the yield (return) goes down.

Generally speaking, when investors make a choice between a stock or a bond, while a particular stock might provide a greater return, a bond offers security. The investor knows how much it will receive and when. Historically, when the economy is doing quite well, investors pull money out of bonds and into the stock market. Lower demand for bonds then means a lower price for the bond. With mortgage backed securities, the method works pretty much the same.

Another bug-a-boo for higher mortgage rates is the rate of inflation. Higher inflation will typically result in higher rates as the Fed looks for ways to cool down an overheated economy. Or, as is currently,  various increases in commodities and everyday consumer goods can rise as well. This is the current cycle we see ourselves in. And while the Fed stood pat at their last round of meetings, they indicated they’ll be at the ready the next time around. It’s quite possible another rate bump by the Fed is already cooked in the books. We’ll see. But the gambling money is on one more Fed increase at their next round of meetings in a few weeks.

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David Reed

David Reed (Austin, TX) is the author of Mortgages 101, Mortgage Confidential, Your Successful Career as a Mortgage Broker , The Real Estate Investor's Guide to Financing, Your Guide to VA Loans and Decoding the New Mortgage Market. As a Senior Loan Officer and Mortgage Executive he closed more than 2,000 mortgage loans over the course of more than 20 years in commercial and residential mortgage lending. 

He has appeared on CNN, CNBC, Fox Business, Fox and Friends and the Today In New York show. His advice has appeared in the New York Times, Parade Magazine, Washington Post and Kiplinger's as well as in newspapers and magazines throughout the country. 

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