How Are Mortgage Rates Determined?

With the U.S. economy back on the rise and the housing market showing signs of improvement, people rekindling their interest in home buying may wonder how home mortgage rates are determined. Contrary to popular belief, the lender is not solely responsible for determining home mortgage rates. Several factors and conditions figure into interest rates. Not coincidentally, they all center around investors. A few of the most important areas are as follows:

1. The inflation rate. If the rate of inflation is high, investors who buy home mortgage securities will expect higher returns to recover that loss of value. This translates to higher interest rates on mortgages. The inflation effect works across the board, no matter how financially solid a potential home buyer is.
2. General economic conditions. Again, this is an effect that the individual home buyer has little control over. When the economy is booming and investors in mortgage backed securities are expecting higher returns, mortgage interest rates will naturally rise. Or, on the opposite end, if the housing market is experiencing a big bust (think 2008), investors will expect higher interest rates because the investments are less secure.
3. Trends with other homeowners. The behavior of home buyers at large impacts the housing market, and interest rates, heavily. Trends involving initial purchases, borrowing, and refinancing causes fluctuations in how investors value mortgage backed securities. And, following the trend of the previous points, changes in the expectations of investors equal changes in the interest rate home buyers receive.
4. You and your lender. The final and most well understood factor in determining home mortgage interest rates is the perceived risk involved with lending to a specific person. If a potential home buyer is financially stable and has a good credit history, they are more likely to receive a lower interest rate.  This is really the only factor a home buyer can directly control. Conventional wisdom says the best strategy for planning to buy a home is to actively keep your credit good, and to pay attention to the other, more volatile factors  in order to find the right time and place to buy.

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How Are Mortgage Rates Determined