How Mortgage Interest Rates are Determined and How to Choose a Lender

On the simplest level mortgage interest rates are determined by the amount of risk a lender assigns to making a loan.  Specific risk factors such as credit, equity, income, assets and property type are critical in determining whether or not a lender will approve a mortgage.  However, these risk factors play only a small role in determining the actual rate.

The biggest factor in determining the interest rate that an applicant receives on a mortgage is the lender’s current “Market Rate,”  which is affected by many factors that are outside of the applicant’s control.  The Market Rate is determined primarily by the demand for mortgage-backed securities issued by the agencies that purchase and or insure mortgages in the secondary market.

Mortgage-backed securities are bonds issued mainly by Fannie Mae and Freddie Mac, and are sold to investors much like any other debt instrument.  Demand for this product will vary depending upon the relative performance of other investments such as stocks and both foreign as well as U.S. government debt.  While there is a common conception that the market rate for mortgages moves in the opposite direction of the U.S. stock market, that is by no means a rule.  Other domestic and foreign factors such as government policy, economic policy and foreign exchange fluctuation can cause both markets to move independently of one another.

As a consumer none of these economic or political factors should be of concern as it pertains to deciding which lender or loan product to choose. All that matters is whether or not you’re getting the best available loan terms given current market factors and the risk factors (e.g. credit, equity, income, assets, and property type) associated with your loan application. It is also important to keep in mind that the Market Rate will vary depending upon your loan term. For example, shorter-term mortgages such as 10 or 15-year terms will carry lower rates as will loans that become variable. Variable loans are also known as adjustable rate mortgages, (ARM).

Given the number of factors associated with determining interest rates it would be a complicated task for anyone to determine what theirs should be. The good news is that the retail market for mortgages is quite competitive, with many mortgage lenders and brokers vying for market share. This creates an environment where most lenders’ rates are very close to one another on an “apples to apples” basis (e.g. for the exact same applicant or set of risk factors).  This environment is also heavily regulated to the extent that the days of any lender charging excessive rates or fees, relative to the market, are effectively over.

While rates play a very important role, trust in the individual and company you are working with is a very close second in terms of what you should consider when deciding which lender to choose.  In the past few years underwriting guidelines and the process of obtaining a mortgage have become increasingly complicated.  Because of this it has never been more important to work with a knowledgeable lender from a reputable company.   On the bright side, the same factors that have led to more stringent qualifying criteria have also resulted in a significant decrease in interest rates.  Although you may have to provide more paperwork and wait longer to get your mortgage now, it is also an excellent time to take advantage of today’s record low interest rates.

Brad Vocino

Mortgage Loan Officer

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