How Mortgage Rates are Set and Regulated

August 8, 2016

Your home is likely one of the biggest purchases you make in your lifetime. A home is so expensive that you probably need to borrow to afford the home purchase. Whenever you borrow money, you pay for the privilege in the form of interest. How much you pay for your home depends on your mortgage rate.

Understanding how mortgage rates are set can help you get the lowest possible rate on your home loan and reduce the overall cost. Here are some of the factors that influence how mortgage rates are set:

Secondary Market Forces

National rates are with the help of market forces. You might be surprised to learn that there is a secondary market for mortgages. It’s one of the ways that lenders keep money moving through the system. After lending you money, a bank or credit union can sell your mortgage to someone else — usually Fannie Mae or Freddie Mac. This allows your lender to get the money back faster so it can be lent out to another borrower hoping to buy a home.

Fannie and Freddie (and other institutions that buy mortgages from lenders) bundle these loans together into investment vehicles that behave like bonds. These are called mortgage-backed securities. They offer returns to investors who buy them on the market. This is where market forces come in with your mortgage rate. Investors are willing to buy with a certain return, so lenders offer rates based on what the market accepts.

Other than regulation overseeing mortgage-backed securities, there isn’t much regarding what the government can do. It’s true that monetary policy, like setting the Fed Funds Rate, can influence economic conditions that impact the markets, but most of the regulation of mortgage rates happens indirectly. Plus, you are more likely to get an idea of where mortgage rates are headed by paying attention to the 10-year Treasury yield.

Individual Factors and Your Mortgage Rate

Of course, the market just provides a baseline for mortgage rates. What you end up is influenced by individual factors as well. The mortgage rates in your locality might be higher or lower than what’s available in another town, just because of the community makeup and types of homes sold in certain areas. Mortgage rates can even vary based on the neighborhood in which you choose to buy.

Additionally, the type of mortgage you apply for matters. Jumbo mortgages have higher rates than smaller mortgages. A construction mortgage or investment property mortgage probably comes with a higher rate than an existing residence. The mortgage rate on your second home is probably higher than it is on your primary residence.

Your credit is a big deal when it comes to mortgage rates. You need good credit to qualify for the lowest possible rate offered by the market. A lower credit score means a higher interest rate on your home loan. Before you apply for a mortgage, it’s a good idea to know your credit situation. If you need to make changes to your finances to increase your chances of getting a better rate, take some time to evaluate the situation and make improvements before seeking a home loan.

If you finance some of your fees, that can also be part of the overall rate. You do have protections, though. There are laws that prevent lenders from charging a higher interest rate than can be justified, and excessive fees aren’t supposed to be financed into the loan. These regulations can help keep your mortgage rate a little lower since they discourage lenders from taking advantage of you by charging excessive interest.

Bottom Line

Your mortgage rate is determined by a combination of market forces and individual financial factors. Take the time to learn about what shapes your mortgage rate. While you can’t control the market forces that influence mortgage rates, you can manage the individual factors that result in your final result. Pay attention to the type of home you buy, where you buy it, and your credit situation. Try to arrange matters so that when you apply for a mortgage, your finances and credit are ready, and you choose a home that fits your needs.

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