How Mortgage Rates Are Determined: A Quick Guide

8 Min Read
Updated Dec. 21, 2023
Aerial photo of a residential street in Dallas, Texas.
Written By Miranda Crace

Mortgage rates are determined by a combination of market trends such as overall economic health and personal factors such as your credit score, how you occupy your home and the size of your loan compared to the value of the property you’re purchasing.

While that’s the long and the short of it, we’ll jump into the details so that you can be fully confident in your knowledge of mortgage rates and what you can do to get a favorable one.

What Determines Mortgage Rates?

Mortgage rates are affected by a variety of economic factors. These include bond market fluctuations, changes to the federal funds rate and the wider housing market. Your mortgage’s interest rate will also be impacted by your own financial situation, such as your credit score, down payment amount, and outstanding debt.

Let’s take a closer look at the most important factors that determine a borrower’s mortgage rate.

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Market Factors That Affect Mortgage Rates

The following factors are forces borrowers can’t control, but will still affect their mortgage’s interest rate. By learning about the effects of each factor, you can be more informed about the potential interest rate you may qualify for.

1. The Secondary Mortgage Market

Like a lot of finance products, mortgages can be traded among investors. The particular mechanism for trading home loans are mortgage bonds and mortgage-backed securities (MBS).

Mortgage bonds and MBS are collections of loans with similar characteristics, such as down payment amount, credit score or the original investor in the loan – for example, Fannie Mae or Freddie Mac or a government investor like the Federal Housing Administration (FHA) or the Department of Veterans Affairs (VA). Both of these financial products are sold on the secondary mortgage market as investment opportunities.

Based on your personal characteristics, your mortgage gets bucketed into an MBS or bond. Investors who are purchasing MBS or bonds make decisions about which ones to buy based on their risk tolerance and desire for a certain rate of return.

When a lot of investors purchase MBS and mortgage bonds, this affects mortgage rates, typically making them trend downwards. This is because the rate on the underlying mortgage bond or MBS doesn’t need to be as high in order to attract an investor. On the other hand, if money is moving away from the secondary mortgage market into stocks or anything else, mortgage rates tend to rise as an enticement for an investor to buy bonds or MBS.

2. The Federal Funds Rate

One of the core missions of the Federal Reserve is to maintain a stable rate of inflation. Their primary tool for doing this is the federal funds rate. The federal funds rate (or fed funds rate) is the rate at which banks borrow money from each other overnight.

Influencing the amount of money banks borrow from each other helps the Fed effectively control the money supply. If short-term interest rates are low, money is cheaper to borrow, which has the effect of increasing the overall money supply in the market and pushing prices up. On the other hand, if interest rates are higher, less money is available, and prices go down.

In other words, if the Federal Reserve lowers the federal funds rate, market rates tend to drop, meaning that mortgage rates may also decrease. If the fed funds rate increases, interest rates also increase. This, in turn, can offset inflation. For example, the Federal Reserve kept short-term interest rates at or near 0% in response to COVID-19. This is what caused the historically low mortgage rates of the following years.

3. Overall Economic Health

Both the Federal Reserve and the overall markets are reacting to the ups and downs of the economy as a whole. Here are a few examples.

Investment Trends

Generally, if people believe we’re in prosperous times they’ll move their money into stocks, and away from bonds, for the chance at a higher return. This could make mortgage rates move upwards. But, if investors believe we’re looking at a downturn in the future, money gets moved back into bonds and mortgage rates go down.


Inflation also plays a role. When inflation is higher, people are more incentivized to invest in stocks. The reasoning is that the guaranteed rate of return on bonds gets reduced as inflation rises.


Finally, unemployment plays a part. If more people are unemployed than the Fed would like to see, they tend to lower interest rates to stimulate borrowing, which in turn may be used to help grow a workforce.

Personal Factors That Determine Mortgage Rates

There are several factors unique to you and your situation that affect your mortgage rate. Among them are your credit score, the down payment or equity amount you bring into the transaction, and how you plan to occupy the home. Finally, what type of home loan you use also has an effect on your interest rate.

4. Credit Score

One of the most important factors mortgage lenders take into account when qualifying you for a home loan is your credit score. This three-digit number essentially describes your creditworthiness and how likely you are to pay back the loan.

If everything else is held equal, the higher your credit score, the longer the history you likely have of being able to make monthly payments on time. If a lender sees this, they’ll know you’re less likely to default. Therefore, you get a lower rate than someone whose credit score might not be as good.

It’s important to note that although there are three credit bureaus, the score that counts is the lowest median score of all co-borrowers on a loan. If you had a median score of 640 and your spouse had a 620 median credit score, the 620 score would be the one that lenders evaluate.

5. Down Payment Or Equity

Your down payment or the amount of the existing equity you have in a refinance has a major effect on the interest rate you can get as well. The higher your down payment, the less a lender has to give you to fund the transaction, which in turn brings down the risk associated with the mortgage.

This is because lenders assess each home buyer’s loan-to-value ratio (LTV). This is your loan amount compared to the appraised value of the property being financed. Simply put, it’s the reverse of your down payment or existing home equity. The lower your LTV, the bigger the down payment or amount of equity, and the lower your interest rate.

Additionally, if you have a down payment of less than 20%, mortgage insurance is required on conventional loans. You can choose to have borrower-paid mortgage insurance, which entails a monthly fee, or lender-paid mortgage insurance. If you opt for the latter, you end up with a higher interest rate.

6. Owner Occupancy

Another factor that really plays into your mortgage rate is how you plan to occupy the property. Is it a primary residence, second home or an investment property? You get the lowest rate on a primary property, while rates may be slightly higher for a vacation home and even higher for an investment property. Again, this goes back to risk for the lender.

If you get into financial trouble, you’re going to make the payment on your primary property before you would make one on your second home.

7. Type Of Mortgage Loan Or Refinance

The type of mortgage or refinance you use will also affect your interest rate. That’s because some loans may be less risky to your lender than others.

For example, government loans are backed by a federal agency, like the FHA or VA. These types of mortgages tend to come with lower interest rates because they’re insured, meaning your lender will get paid back a certain percentage of your loan amount even if you default.

The same can be said for some types of refinances. If you’re looking to convert your home equity into cash, you’ll get a slightly higher rate than if you were buying a new home or doing a refinance solely to lower your interest rate or change your term. This is because you’re taking on a higher balance than what you had going into the transaction, which entails more risk for lenders and mortgage investors.

The Bottom Line: Mortgage Rates Are Affected By Economic And Personal Factors

Before you apply for a mortgage, it’s important to understand the several market-based and personal factors that have a direct impact on your interest rate. None of them can be removed from the process.

Market factors, like the secondary mortgage market and federal funds rate, will impact current mortgage rates beyond your control. But personal factors, such as your credit score, down payment amount and the type of mortgage you use, are within your control and can be altered to improve your interest rate. For instance, increasing your down payment or improving your credit score can help you land a lower interest rate and more affordable mortgage payment.

Now that you have a better understanding of how mortgage rates are set, perhaps you’ll be more prepared and know what you can do in order to get a better rate. If you’re ready to apply, you can today to see what rates and terms you’ll qualify for.