How are Mortgage Rates Determined? And Why are They Always Changing?

Good news: Mortgage rates are the lowest they’ve been in a while.

In fact, compared to a year ago, rates have dropped almost a full percentage point Off Site Link, according to Freddie Mac. The change comes as many worry of a possible recession after seeing the infamous inverted yield curve, which has forecasted every economic downturn in recent memory.

Mortgage rates are determined through a number of varying factors and don’t lend themselves to simple equations.

We know that borrowers who provide a higher down payment and have strong credit scores can receive a better rate, but on a larger scale, these numbers are decided by a combination of the secondary market, inflation, the Fed and the stock market.

Confused yet? Don’t worry. We’ll unpack these four factors in plain language and discuss the effect they could have on your monthly house payment.

The Secondary Market

Banks originate mortgage loans and then sell them to third party investors like Fannie Mae or Freddie Mac, which are referred to as aggregators. Once the aggregators buy these mortgages, they divide them into shares, or tranches, as they’re called, and sell them to other investors.

Because your bank, or the loan originator, sells your mortgage to a third party, it will need to do so at a competitive rate. Therefore, the secondary market plays an important role in determining your mortgage rate.

Generally, when the economy is in good shape, investors will want to put their money in mortgages with high yields – mortgage rates – in order to get the most bang for their buck. On the other hand, when the economy is slumping, mortgage rates go down as investors will take what’s available in an effort to avoid losing money later.

The mortgage-backed securities that institutions sell to investors are reliable investments. According to the Mortgage Bankers Association, mortgage delinquency rates on one-to-four-unit properties are around 4.2%.

Inflation + The Federal Reserve

Inflation affects mortgage rates, too, and not to the benefit of homebuyers.

Inflation refers to a surge in prices and therefore a drop in the value of currency. And when inflation is high, loans become riskier and banks want higher mortgage rates to appease third-party investors. That said, you’re better off looking for a home loan when the economy is on the upswing.

The federal funds rate is another predictor of mortgage rates. This is the rate banks use when making overnight loans to other banks. When this rate is raised, consumers will likely see a rise in mortgage costs to cover the increased rate.

The yield on U.S. Treasury notes plays a factor, too. When the Treasury yield goes up, so do mortgage rates, and vice versa.

The Stock Market

The stock market is a peripheral factor in how high your mortgage rate will be. It doesn’t affect the rate directly, but could be an indicator of when to buy.

If, for example, stocks are down, investors will gravitate towards secure investments like a mortgage-backed security. And if that’s the case, you might get a lower mortgage rate since they’re in high demand and can be sold at a lower price.

Stocks are volatile investments that depend on the success of an industry or company. Mortgage-backed securities, on the other hand, aren’t as risky given the low delinquency rate mentioned earlier.

Keep Up on the Trends

Mortgage rates rise and fall based on a number of different variables. Most of the ebb and flow that rates experience is contingent on factors that are completely outside of prospective buyers’ control.

There’s no fail-safe formula for deciding when to buy or when to hold off. But keeping up with general economic trends doesn’t hurt. The more you know about the market, the better off you’ll be as a consumer.

Establishing a strong payment history and saving habits will also help in becoming a homeowner. Lenders likely won’t borrow money to someone with poor credit.

Learn more about mortgage options from Sunrise Banks.

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