Mortgage interest rates have a significant impact on the cost of financing a home. Onone hand, borrowers seek the lowest possible mortgage rates. On the other, lenders manage their risk through the interest rates they offer. The lowest rates are only available to borrowers with the most stellar credit histories.
While your financial health helps determine the rate you get on your mortgage, other factors affect the mortgage rate environment. There are five major factors at play, and all of them reflect the basic rules of supply and demand in one form or another. Some of these factors are complex, but understanding these principles explains the interest rates you are paying now and what could be coming in the future.
Key Takeaways
- Inflation influences how lenders set their mortgage rates.
- Consumers are likely to borrow more during periods of economic growth, which often leads to higher interest rates.
- Although the Fed doesn't set them, mortgage rates are impacted by the Fed funds rate.
- Bond market conditions have an indirect effect on how much lenders charge for mortgages.
- A drop in demand for housing inventory often leads to a drop in mortgage rates.
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Inflation
Inflation refers to the rise in prices for goods and services. As such, the buying power of one unit of currency drops, which means it erodes the purchasing power of dollars over time.
The gradual upward movement of prices due to inflation is a reflection of the overall economy and a critical factor for mortgage lenders. Lenders generally have to maintain interest rates at a level that is at least sufficient to overcome the erosion of purchasing power through inflation to ensure that their interest returns represent a real net profit.
For example, if mortgage rates are at 5% but the annual level of inflation is at 2%,the real return on a loan in terms of the purchasing power of the dollars the lender gets backis only 3%. Therefore, mortgage lenders carefully monitor the rate of inflation and adjust rates accordingly.
The Rate of Economic Growth
Economic growth indicators, such as gross domestic product (GDP) and the employment rate, influence mortgage rates.
With economic growth comes higher wages and greater consumer spending, including consumers seeking mortgage loans for home purchases. That's good for a country's economy, but theupswing in the overall demand for mortgages tends to propel mortgage rates higher. The reason behind this is that lenders only have so much capital to lend.
The opposite is true when the economy starts to slow down. Employment and wages decline, leading to decreased demand for home loans, which puts downward pressure on the interest rates offered by mortgage lenders.
Mortgage rates may be fixed or adjustable. Fixed-rate mortgages remain the same throughout the life of the loan. Adjustable rate mortgages (ARMs) begin with a fixed rate and fluctuate after that.
Federal Reserve Monetary Policy
The Federal Reserve is the central bank of the United States. The Fed oversees the country's financial system, ensuring it remains safe and sound. As such, it is responsible for achieving maximum employment and maintaining stable prices.
The monetary policy pursued by the Federal Reserve Bank is one of the most important factors influencing both the economy generally and interest rates specifically, including mortgage rates.
The Federal Reserve does not set specific interest rates in the mortgage market. However,its actions in establishing the Fed Funds rate and adjusting the money supply upward or downward have a significant impact on the interest rates available to the borrowing public. Increases in the money supply generally put downward pressure on rates while tightening the money supply pushes rates upward.
The Bond Market
Banks andinvestment firms market mortgage-backed securities (MBSs) as investment products. The yields available from these debt securities must be sufficiently high to attract buyers.
Part of this equation is the fact that government and corporate bonds offer competing long-term fixed-income investments. The money you can earn on these competing investment products affects the yields the MBSs offer. The overall condition of the larger bond marketindirectly affects how much lenders charge for mortgages. Lenders have to generate sufficient yields for MBSs to make them competitive in the total debt security market.
One frequently used government bond benchmark to which mortgage lenders often peg their interest ratesis the 10-year Treasury bond yield. Typically, MBS sellers must offer higher yields because repayment is not 100% guaranteed as it is with government bonds.
Housing Market Conditions
Trends and conditions in the housing market also affect mortgage rates. When fewer homes are being built or offered for resale, the decline in home purchasing leads to a decline in the demand for mortgages and pushes interest rates downward.
A recent trend that has also applied downward pressure to rates is an increasing number of consumers opting to rent rather than buy a home. Such changes in the availability of homes and consumer demand affect the levels at which mortgage lenders set loan rates.
Mortgage Rates by Bank
The table below highlights average mortgage rates for first-time homebuyers for the 30-year fixed, 15-year fixed, and 7-year/6-month adjustable rate loan for some of the major banks as of Dec. 12, 2023. Keep in mind that rates vary based on location and credit score.
| Sample of Average Mortgage Rates | |||
|---|---|---|---|
| 30-Year Fixed | 15-Year Fixed | 7-Year/6-Month ARM | |
| Bank of America | 7.25% | 6.25% | 7.00% |
| Chase | 6.75% | 5.99% | 6.875% |
| Citi | 6.875% | 6.25% | contact Citi |
| TD Bank | 6.75% | 6.125% | contact TD Bank |
| US Bank | 6.75% | 6.25% | 6.50% |
| Wells Fargo | 6.50% | 5.875% | 6.625% |
How Much Does One Point Lower Your Mortgage Rate?
Mortgage points are a key part of the closing process. Some lenders allow you to pay points with your closing costs in exchange for a lower interest rate. This essentially gives you a discount and cuts down your mortgage payment. One point typically represents 1% of the total mortgage, so one point on a $200,000 mortgage would be $2,000. The amount of a single point depends on the type of mortgage and can be as high as 0.25%.
What's the Difference Between a Conventional and FHA Mortgage?
Conventional mortgages are offered by private lenders and are not backed by the government. They may be conforming, which means they meet standards set by Fannie Mae and Freddie Mac, or they may be nonconforming, which go above certain loan limits. Conventional loans typically come with higher qualifying requirements, such as higher credit limits and down payments.
FHA loans, on the other hand, are insured by the Federal Housing Administration and issued by an approved lender. This means that these loans are backed by the government. The qualifications are often less stringent than conventional loans, which means people with lower credit scores can also qualify. You can also qualify with a lower down payment.
How Many Times Can You Refinance Your Mortgage?
There is no limit to the amount of times you can refinance your mortgage. Keep in mind that you must qualify whenever you apply for a refinance and you must have equity in your home to be approved. Having said that, there are certain benefits to refinancing, including getting a lower interest rate and improving the terms of your loan (like the amortization period), among other things. You will be required to pay additional fees, though, such as origination fees, closing costs, and even prepayment costs if they apply. These can all add up and eat away at your bottom line.
The Bottom Line
Mortgage rates are tied to the basic rules of supply and demand. Factors such as inflation, economic growth, the Fed’s monetary policy, and the state of the bond and housing markets all come into play. Of course, a borrower's financial health will also affect the interest rate they receive, so do your best to keep yours as healthy as possible.
