How are mortgage rates determined?
Mortgage rates are determined by market conditions and personal factors. Mortgage rates (especially 30-year fixed rates) are often more heavily influenced by the 10-year Treasury note rather than the federal-funds rate. Comments from policymakers, as well as concerns about economic headwinds, can influence the mortgage market. Lenders also take into account their own margins, the perceived risk you present as a borrower and what rates other lenders offer when presenting you with a rate quote.
Average mortgage rates are determined by adding a spread to the 10-year Treasury note’s rate. How big that spread is depends on the mortgage industry costs. Normally, those costs are reflected in the difference between what’s being offered to borrowers and the rate reflected by mortgage-backed securities. Many mortgages are bundled into securities that investors can purchase.
On top of that, rates are also influenced by the difference between mortgage-backed security rates and the 10-year Treasury note rate. Investors often require higher rates on mortgage-backed securities because they come with greater risks than a Treasury note.
When you add the two spreads — the difference between what borrowers are offered and what mortgage-backed securities pay, as well as the difference between the 10-year Treasury rate and mortgage-backed securities rate — to the 10-year Treasury note rate, you end up with your average mortgage rate.
Factors that influence rates
Home loan rates are influenced by macro and personal factors. Macro factors include items like monetary and fiscal policy, as well as investor expectations. Personal factors hit a little closer to home, including your credit history, loan term and income.
Macro factors
The 30-year fixed rate is tied to the 10-year Treasury note. Generally, when the rate on the 10-year note moves higher, mortgage rates follow suit. If the note’s rate drops, mortgage rates are usually close behind in moving lower.
Factors influencing the 10-year Treasury note are usually connected to monetary and fiscal policies that can affect inflation and potential economic growth. While the federal-funds rate doesn’t directly influence mortgage rates, it can provide clues about what might be next for the economy and what steps policymakers might take. If investors think that economic and market conditions will lead to less favorable rates of return on short-term Treasury notes, they might be willing to purchase more 10-year notes in the hopes of better long-term results.
Personal factors
The mortgage rate quote you receive from your lender usually accounts for larger economic conditions as well as your borrower profile. Some personal factors lenders consider when offering a mortgage rate quote include:
- Credit history and score: Your credit history and score are considered indications of how likely you are to repay your debt. If you have a higher credit score and a credit history that indicates you make on-time payments, you’re likely to pay a lower mortgage interest rate.
- Income: Your income, especially relative to other debts you have, is also considered when setting your mortgage rate. If your income is high enough to handle your monthly mortgage payments, plus your other debt payments, you’re likely to get a lower mortgage rate.
- Loan terms: The length of your mortgage can also influence your rate. For example, 15-year fixed rates are generally lower than 30-year fixed rates. Additionally, you might get a lower initial rate with an adjustable-rate mortgage.
- Down payment: By making a larger down payment, you could potentially reduce your mortgage rate.
- Points paid: You can also reduce your mortgage interest rate by directly paying more in upfront costs. A point is one percent of your loan amount. For each point you pay, your rate might be reduced by up to 0.25 percentage points.
How to qualify for the best mortgage rates
To qualify for the best mortgage rates, you generally need a credit score in the “excellent” range, depending on the lender. Credit reporting agency Experian suggests that you need a credit score of 760 or higher to access the best rates.
Additionally, you typically need to meet debt-to-income ratio (DTI) requirements. Some lenders might require your mortgage payment to be no more than 25% to 28% of your monthly income to qualify for the best available mortgage rate. On top of that, they might also look at your total DTI — including your new mortgage payment — and only offer the best rates if your total debt payments remain no more than 33% to 36% of your monthly income.
If you meet these two conditions, you’re usually well-placed for the best mortgage rates. However, you might need to make a larger down payment and choose a shorter loan term if you want an even better home loan rate quote.
How to shop for the best mortgage rate
When comparing mortgage rates, start with three to five lenders. Get a quote from each one, comparing loan terms. Make sure you’re comparing the same terms across lenders to get a more accurate quote.
Even if you end up with a hard credit check, if you get your quotes within a 45-day window, most credit scoring models consider them as one inquiry.
In addition to comparing rates, find out what fees and closing costs are charged. Ask for a loan estimate from each of the lenders so you can compare all the expenses associated with each part of the loan. You should also find out whether each lender offers a rate lock, and how long that rate lock lasts.
Mortgage payment tips for long-term savings
Reducing the time you pay interest is one of the best ways to save money on your mortgage long-term. Consider different strategies that can help you get out of debt faster and save on interest charges.
Set up biweekly payments
Biweekly payments can help you save money on interest and pay off your mortgage a little faster without adding extra stress to your budget. To set up biweekly payments, divide your monthly payment in half and arrange to make a payment every other week. This works out to 26 payments a year, the equivalent of making an extra monthly payment.
For example, if you borrow $350,000 at a 30-year fixed rate of 6.59%, you could potentially save a little more than $105,000 in interest over the life of your loan.
Pay extra toward principal
By making extra principal payments, you directly impact what you originally borrowed. Interest is based on your principal amount, so paying down your principal can result in long-term savings. Additionally, you build equity faster with additional principal payments and reduce your total debt.
Refinance your loan
If mortgage rates fall in the future, you might be able to refinance your home loan to a lower rate. When you refinance, you use a new loan to pay off the old loan. In some cases, you might also get a lower monthly payment when you refinance to a lower rate. Refinancing is more likely to be effective if you keep your current term. For example, if you refinance after having your mortgage for 10 years, it might make sense to refinance to a 20-year mortgage rather than getting a new 30-year mortgage.
FAQ
How often do mortgage rates change?
Mortgage rates change frequently. Freddie Mac updates its survey of average mortgage rates weekly.
Can I lock in a mortgage rate?
Yes, you can usually lock in a mortgage rate as part of the pre-approval process. Depending on the lender, you might be able to secure a home loan rate for 30, 45 or 60 days.
How does my credit score affect the mortgage rate I receive?
The higher your credit score, the more likely you are to qualify for a lower home loan rate.
What is the difference between APR and interest rate?
An interest rate is the percentage of the loan amount you pay each year as a cost of borrowing money. The annual percentage rate (APR) includes upfront costs and fees in the rate and is usually slightly higher than the interest rate.
What other costs go into securing a mortgage rate?
In addition to market and personal factors, you might be able to get a lower mortgage rate by paying discount points. Paying these points or fees upfront can help reduce your mortgage rate.
