Mortgage Rates

The factors driving the ebbs and flows of mortgage rates are largely unknown to the general population. You may be inclined to blame -- or commend -- your mortgage lender for the low or high rate she offers you; but, in actuality, it's not her decision. Today, the true drivers of mortgage rates are the investors in the secondary market.

To the layman's eye, mortgage rates seem to move up and down without explanation. But, just like the ocean tides that wash up and back by the pull of the moon's gravity, mortgage rates have their own driving force, even if they have a less cosmic source.

The mortgage lender that funds your loan is called the originator. A loan originator may be a bank, a credit union, or other type of financial institution. On the date of funding, the money flows out of the originator's hands and into yours. You then turn that money over to the seller of the home.

Once the loan is funded, the originator has the option of keeping that loan in its portfolio or selling it on the secondary market. If the originator keeps the loan, it makes money by way of the interest you pay each month. If the loan is sold, the originator replenishes its funds, and can make more loans to other homebuyers. Basically, the secondary market investors keep funds circulating so that loan originators don't run out of money for new mortgages.

Today's secondary market investors include government-chartered companies like Fannie Mae and Freddie Mac, plus insurance companies, pension funds, and securities dealers. Although Fannie Mae and Freddie Mac are different organizations, they participate in similar activities. Both can buy mortgages, and both can group mortgages together for resale in what's called mortgage-backed securities (MBS). These are highly liquid investments, meaning that they can be readily bought and sold.

How does the secondary market affect you as a would-be homebuyer?

Investors want to earn the best return possible. The level of return is determined by the current and anticipated condition of the economy. When the economy is on an upswing, future yields are expected to be better than current yields. Investors, therefore, will hold off buying until higher yields materialize. This drives mortgage interest rates up, because lenders cannot sell their loans at lower yields.
Conversely, when the economy is in a downturn, investors buy up what's available to avoid being stuck with lower yields later. This drives mortgage rates down, as investors are clamoring to buy before yields get too low.

Keeping your eye on mortgage rates

There are many factors that influence mortgage rates, including unemployment and inflation levels, trends in the stock and bond markets, and the federal funds rate. None of these alone will give you surefire insight into the future of rates, but by keeping your eye on all of them, you can have some sense where they are headed.

As mentioned earlier, the secondary mortgage market provides liquidity for the mortgage industry, by allowing investors to buy the aforementioned mortgage-backed securities, which pay a competitive yield relative to the risk involved. Treasury bonds are backed by the U.S. government and used as a benchmark, and are considered the safest debt securities available. The yields on mortgage-backed securities, therefore, need to be higher than intermediate-term Treasury bonds in order to make them desirable to investors, who are assuming a higher risk. Therefore, changes in Treasury bond yields can foreshadow changes in mortgage rates before they actually occur.

Another metric to keep your eye on is the federal funds rate, which is the rate that banks charge when they make an overnight sale to other banks of the money that they keep deposited at the Federal Reserve. The fed funds rate is set during meetings of the Federal Open Market Committee (FOMC), which regulates the buying and selling of U.S. Treasuries and federal agency securities. The FOMC holds eight meetings each year, where they review economic and financial conditions, and decide the best course of action to take to set monetary policy and keep the economy stable. A decrease in the rate will stimulate growth, and an increase will slow growth. Therefore, in periods of high inflation, the FOMC may raise interest rates, and in a period where they need to stimulate the economy, they will lower them. At each meeting, they will either lower, raise, or maintain the fed funds rate. Their decision will impact mortgage rates.

The fed funds rate is intermeshed with the stock market, because stock market trends influence – and are influenced by – the fed funds rate. If the market is struggling and in a downward trend, the FOMC may opt to reduce the fed funds rate and free up the supply of money. Conversely, if the market is on a tear, the Fed may increase the rate in order to keep the economy from overheating.

Types of mortgage rates

There are two types of mortgage rates available for a home loan – fixed and adjustable. With a fixed-rate mortgage (FRM), the rate will stay the same over the entire length of the loan. The same goes for your monthly payment. People who choose fixed-rate mortgages have an easier time planning their budgets. They also have no exposure if interest rates go up.
An adjustable-rate mortgage (ARM) is based on an index, and the mortgage rate will fluctuate over the life of the loan. An ARM will likely have a lower interest rate at the beginning when compared to a fixed-rate mortgage; but over the life of the loan, that could drastically change, especially if the economy heats up, and interest rates begin to rise. ARMs are especially risky because you may end up owing more money than you borrowed, even if your payments are all made in a timely manner.

Finding the best mortgage rate

Once you determine which type of mortgage rate you want, it’s time to start shopping. Instead of shopping for a home and then applying for a mortgage, try reversing the order – talk to a few mortgage professionals for some advice on your qualifications, and then get pre-qualified for a loan or, even better, get pre-approved. If you have your mortgage in hand, you will be in a stronger negotiating position with the seller, because he will know that no financing contingencies will be required. Also, if mortgage rates are favorable, it will allow you to act quickly to lock in a preferred rate once you find the property that you would like to buy.

To get the best mortgage rate available, you’ll want to show the bank that you are credit-worthy by having the best credit score possible. That’s why it’s imperative to check your credit report before you begin applying for a mortgage. Banks use credit scores to determine whether you’re a good risk, and if you’ll be someone who makes mortgage payments on time. If you have a pattern of paying your bills promptly, you’ll be in a great position, but that’s not something you can establish overnight. If you have a low credit score, there’s a higher risk that you’ll miss payments or, even worse, default on the loan completely.

Once you get a copy of your credit report, review it carefully for any errors. If you find them, contact the credit reporting agency and have it corrected as quickly as possible. If you can’t do that in time for your application, you can always let the bank know that there’s an error and you’re in the process of correcting it.
Another way to get the lowest mortgage rate available is to increase your down payment. Most lenders now require that you put 20 percent down, but if you can pay more upfront, it will lower the amount of mortgage you need to take, and may also lower your loan’s rate.
Ask your lender if you qualify for a loan that is backed by Fannie Mae or the FHA, because these generally carry the lowest interest rates. You may also be eligible for a Veteran’s Administration loan if you served in the military.

Finding mortgage rates online

It is now as easy to find a mortgage lender online as it is to find one in a brick and mortar bank. Even if you want to go with a traditional banker, discover the interest rates that competitors are offering in your area. This way, if your local bank is a bit overpriced, you can use it as a negotiating tool. Or you may even prefer to go with an online lender if the difference in the mortgage rate offered is significant.
When searching rates online, it’s important to know exactly what you’re looking for – and take clear notes. You may find that the lowest rates available are all adjustable-rate mortgages, but you’ve decided to go with a fixed-rate loan, because you prefer the stability that it offers. Stick to your guns, and don’t get sucked in by lower rates, as they carry higher risk.
Make sure that you’re finding rates specific to your area. You can do this by checking the rate details, which will be available at the top of the page. Rates will vary from locale to locale and state to state, and a national mortgage average may be irrelevant to your particular area. Also, check to see if the rate includes points, where each point equals 1 percent of the total loan. Each point that you pay will lower your interest rate, so it’s important to determine if the low rates you find online include them or not.
Finally, check to see when the site was last updated. If it’s been a week or more, the published rates may no longer be available. Or they may be available exclusively to people with the highest credit scores.

Locking in your mortgage rate

After your original mortgage application is accepted -- but before your loan closes -- you may be allowed to lock in a mortgage rate. This is a difficult decision to make, because you’re not psychic, and thus can’t really be sure the direction that rates will take over the next 30 to 60 days. If rates are in an upward mode, procrastinating could hurt, and cost you a lower rate. But if rates are trending downward, you could lock in a rate that will be higher by the time everyone is ready to sit down at the closing table. Even professional mortgage brokers, who have vast experience watching rates, can’t be depended upon to make the right call. They may be in a better position to make an informed decision, but no one really knows for sure.

You may be better off taking a long term perspective, and realizing that paying a quarter or half point now won’t make that much of a difference over the long-term.
If you’re confident that a rate lock is right for you, get it in writing. Some lenders have forms that will describe the exact terms of the lock. Don’t allow the agreement to be made orally – when the time comes to close, you don’t want to be dependent on somebody’s memory as to what you agreed upon.

Some lenders will charge you a fee if you decide you want to lock in a rate, along with the number of points that you’d like to pay. If the loan doesn’t close for any reason – even if it’s the bank’s fault – you may not be allowed a refund. The fee will vary from lender to lender, and will depend on the length of time of the lock-in period. You may even find a lender who charges no fee.
There are three different options for rate locks. The first is a locked-in interest rate, and locked-in points, which lets you lock in both for a period of 30 to 60 days. The second is where you lock in the interest rate, but float the points. If rates drop during the lock-in period, you may be able to lower your points. If they rise, the opposite will occur. The third choice allows you to float both the interest rate and points, with the option to lock it in sometime after you apply, but before you close.

As long as you close within the designated time period, your lock-in will take affect. But if you fail to close, you might lose the interest rate you agreed to, and will have to start the process all over again.
By staying on top of financial trends and planning accordingly, you can time your rate lock to get the best mortgage rate possible. In other words, when the tide is low, put a call into your lender and lock in that rate. You'll enjoy waves of prosperity if you do.

How changing rates affect you

Nobody – except lenders -- likes high mortgage rates. Home sellers may have a tougher time attracting buyers who can’t afford the higher rates. And if you want to renovate your home with a home equity loan, it could be quite expensive, because second mortgages are also sensitive to rising interest rates.

Everyone – except lenders -- likes low mortgage rates. Buyers like them because they can lock in great rates for the long term, and sellers like them because buyers may be able to afford a more expensive home because interest rates are lower. When rates rise, it increases the cost of buying a home. For every $100,000 that you borrow, a 1 percent increase in rates will cost you about $64 more per month. That may not sound like a lot, but over the course of 30 years, it can really add up.

In a period of rising interest rates, owners of adjustable-rate mortgages may feel a significant sting as they watch their monthly interest rate and payment adjust higher and higher. If you made the conservative choice and went with a fixed-rate loan, during these times, you simply smile and pat yourself on the back for making a wise financial move.

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