How Mortgage Rates Are Determined

Okay, how are mortgage interest rates determined? Now, so often there's a lot of misinformation out there, you see a lot of things quoted, a lot of fine print. Well, what's your rate? That's a question I get is, hey, what's your rate? You know, you shop around, what's your rate? So, there's the answer to that question? I always say, the answer is, it depends.

There is a few different factors that go into what your interest rate would be, and everyone's interest rate is different, and it's based off a set of principles? First, we start with market-based forces. So, the core of any mortgage rate has to do with what's going on in the economy. How is that reflected in the economy? It's in the bond market. It is called mortgage backed securities. If you imagine all of your neighbors' mortgages, that are all your neighbors, all their mortgages are packaged into one piece of paper, called a mortgage backed security, and that's traded on, on the bond market.

And, your pension funds, and big insurance companies who need to fund your obligations, they buy these bonds, because they pay a rate of return. So, based on the rate of return that they pay. Also, it's based off of things like inflation, the economic news. Usually unemployment or consumer price index, all those economic factors go into how the pricing on those mortgage bonds are determined. And ultimately, the core of those mortgage backed pricing, that's gonna determine the core economic interest rates.

So, in 2020, in lieu of COVID, we had some business closures and shutdowns. And so once a stimulus needs to go into the economy, usually the inflation is tampered down because there's not a lot of economic activity, so rates will drop. And then when the economy is roaring, it happens the other way, where the inflation is going up because you have to hire more people to keep up, and so interest rates pressure is upwards.

So, the core of interest rates will be the economy. Right now we're in a good interest rate market. In 2007, when 7% was all the rage, now rates are in the 5%. So it, it's definitely a great area to be in. So number one is the economic factors. That forms the base rate. So the next 'how' is to determine your risk, your loan's risk.

It all starts, as you may know, with your FICO score. We use the FICO score, and it's FICO version four. We take the middle FICO score out of the three major bureaus. So, FICO score is going to determine one thing. Also, the type of mortgage it is, because there's VA, there's FHA, USDA. Different loan types of different loan features. For instance, FHA and VA are government insured, so the risk of those loans of default is lower. Therefore, they can lower that interest rate. Whereas, conventional loans, without mortgage insurance, there's no assurance of the lender to make those loans so they price that risk higher. Generally the starting interest rate for everyone is just higher on a conventional loan versus FHA and VA.

It all depends on, number one, your FICO; the loan type, is it conventional; and usually the the FICO will tell us which way to go, based on, your personal situation.

Say you had a short sale foreclosure within the three years or more, so you would have to go FHA. So, I'll tell the client-- that's why I say your interest rate will differ from your neighbor's interest rate because of your personal situation. That's how we determine, the interest rate on FHA, starts with your FICO, and then it gets priced based on risk. Also the certain property, if you're buying a condo, that's going to be more risky because you're sharing walls, it's deeded differently, it's harder to sell. You know, single family homes generally have lower rates because they're easier sold, and it's just, lower risk.

FICO's a consideration, loan type, and also how much you're putting down on a purchase. If you put down more, you usually put down 40%, and your risk is lower because you're building lot equity in; or if you're putting down, you know, the minimum, you know, of course that rate is going to be risked higher.

But also, they mitigate that risk with what's called mortgage insurance. And it's interesting, sometimes if you can get a little bit of mortgage insurance, like if you could put down 15% versus 20%, the conventional loan is insured. There may be a little bit lower rate because lower risk. So, aftermarket worth sources are risk-based sources.

It comes down to your FICO, comes down to how much you're putting down on refinancing/purchase loan to value, if it's a single family home, the loan, the property type, but also if it's owner-occupied.

If you're buying investment property you're having to put more money, the rate is higher because of the rate of default. So, after the core and market rate, they determine your risk rate. And that's how we come up with your interest rate. And what I always do, is have you make a choice. What I always present is options. Something like here's, with no points, and here's buying down points, and it may or may not make sense, but ultimately there's no-- the answer to the question 'what's your rate?' is always, it depends on what your goals are.

So my job for you is to lay out all of your options, what's possible, and then you execute on the solution that works best for you and your family. So, that's how mortgage interest rates are determined. Call me today to go over your scenario so we can determine your rate.

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