How Mortgage Rates are Set

To understand how mortgage rates are set you first need to understand the primary and secondary mortgage markets.

In the primary mortgage market, people buy and sell houses with mortgages. If you’ve bought or sold a home with a mortgage then you’ve participated in the primary mortgage market.

The secondary mortgage market comes into play after the home has been bought or sold. The owner of the mortgage, the bank, credit union, or savings and loan, will generally sell the mortgage on the secondary market.

The purpose of the secondary market it to provide a place for mortgage lenders to sell their mortgages. This frees up mortgage lenders to then turn around and sell more mortgages.

Fannie Mae and Freddie Mac are the main players in the secondary market. They are responsible for keeping the secondary market stable, they establish the acceptable standards for purchasing loans and the price they will accept to buy those loans. Fannie Mae and Freddie Mac buy mortgages, package them as “Mortgage-backed Securities” (MBS) and then sell them to investors.

As investments, mortgage-backed securities generally behave like bonds. As people pay their mortgages the investors reap the rewards of the interest paid on the original loan.

The behavior like a bond is why mortgage rates are said to follow the 10-year Treasury bond. Investors looking to buy MBS are usually looking for relatively stable long term investment so MBS compete with bonds as an investment.

If the demand for MBS falls, then the price falls and the yield, or interest rate, increases. This drives mortgage interest rates up. The opposite is also true, if the demand for MBS increases, the price increases, and the yield decreases, driving down mortgage interest rates.

Rates are not fixed by any individual or organization, they represent a moving target that is the result of market and/or investor demand, economic activity occurring in the financial markets, supply and demand in the housing market and the price Fannie Mae and Freddie Mac are willing to pay to buy certain types of mortgages.

The borrower also has a role in setting the interest rate on their loan. There are a lot of factors, specific to the borrower that will affect their mortgage interest rate. These factors include but are not limited to:

• Loan amount (conforming loan or jumbo)
• Loan type (conventional, FHA, VA, or USDA)
• Loan purpose (primary residence, second home, refinance or investment)
• Loan lock period (45-day, 30-day, etc…)
• Type of amortization (fixed or adjustable)
• Credit history
• Property State and County
• Property type (single family, condo, etc…)
• Debt to income ratio
• Down payment
• Mortgage Insurance

It would be nice to point to one factor or a small set of factors that set a specific rate for mortgages but it isn’t that simple.  All of these factors go into the calculation of a mortgage rate and it can be different for everyone.

For more information contact Aaron Walker or Jay Rapson at Aaron Lending, LLC.