What Are Mortgage Rates And How Are They Determined?

5 Min Read
Updated July 24, 2023
Large brick house against bright blue sky.
Written By Sam Hawrylack

In addition to decisions to make, home buyers have many terms to know. One of the most important is mortgage rates.

If you find yourself asking, “what are mortgage rates and how do they work?”, read on so you can be an informed buyer. Your mortgage is one of the largest loans you’ll take in your lifetime, so understanding how rates work and what you can do to lower them is essential.

What Is A Mortgage Rate?

The mortgage rate is a percentage of interest charged on the home loan the borrow pays back to their mortgage lender. Your monthly payments include the interest and principal, which go to your mortgage lender. A borrower often has the option of a fixed-rate or adjustable-rate mortgage. A fixed-rate mortgage has the same rate for the life of the loan, and adjustable rates change annually after an initial fixed term.

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How Are Mortgage Rates Determined?

Mortgage rates are determined by the mortgage lender. Still, many factors affect the rate a lender can provide, including personal factors, such as your credit score and credit history, and market factors you can’t control.

Factors That Affect Mortgage Rates

Mortgage rates can fluctuate daily and sometimes multiple times a day. The market factors are out of your control and greatly affect your base interest rate. Timing your mortgage when base rates are the lowest will provide you with the best mortgage interest rates.

Market Factors

  • The bond market: When lenders fund mortgages, they sell them as bundled securities on the bond market. The higher demand for mortgage securities lowers mortgage rates, and lower demand increases them.
  • The Federal Reserve: The Federal Reserve uniquely affects mortgage rates. While they don’t directly determine rates, the Fed’s decisions affect mortgage rates in the long run. For example, mortgage rates usually follow when the Fed lowers rates and vice versa. That’s why mortgage rates have followed suit in recent months with higher Fed rates to combat inflation.
  • Economic conditions: Anything that happens in the economy and hits the news can affect mortgage rates. When confidence in the economy is low, mortgage rates fall to entice more borrowers to purchase a home. The opposite is true when there’s good economic news. There’s more demand than most can handle, so rates increase to slow things down.
  • Inflation: Inflation and mortgage rates have a direct relationship. When inflation goes up, so do mortgage rates and vice versa.

Personal Factors

  • Credit history: Your credit history is one of the largest factors you can help affect your interest rate. Your creditworthiness tells lenders if you’re a low or high risk. The lower your credit score is, the higher the default risk you pose, resulting in a higher mortgage rate.
  • Down payment: Your investment in a home also determines your riskiness. The more ‘skin in the game’ you have, the less risk the lender takes. So the larger the down payment you make, the better the interest rate a lender can charge because you’re borrowing less money. The collateral you have in the home is the lender’s guarantee, should you default.
  • Loan-to-value ratio (LTV): Lenders prefer borrowers to have an LTV of 80% or less. This means you put down at least 20% on the home, and they lend you 80%. While you can put down as little as 3% – 3.5% depending on the loan, it can increase the mortgage rate the lender will offer.
  • Loan term: The longer you borrow money, the longer it takes you to pay it back. Shorter terms, like a 15-year loan, will have much lower rates than a 30-year term. However, the tradeoff is a much higher mortgage payment with a 15-year loan because you have half the time to pay the loan in full.
  • Debt-to-income ratio (DTI): Your DTI measures your monthly debt to your monthly income. The more debt you have compared to your income, the less likely you’ll be able to take on more debt, which will increase the interest rate lenders can offer.

Mortgage Rate FAQs

Still have questions about mortgage rates? Here are some more answers.

How Do I Get A Lower Mortgage Rate?

The best way to get a lower mortgage rate is to increase your credit score and decrease your LTV and DTI. Show lenders you’re a responsible borrower and likely won’t default. Proving you have a solid credit history, money to put down on the home and you aren’t overwhelmed with debt will help you get the lowest rates available based on current market trends.

What Is A Good Mortgage Rate?

Mortgage rates fluctuate daily, and a good mortgage rate can change with the times. A few years ago, interest rates were as low as 2%, but today are closer to 6% – 7%. So a good mortgage rate is at the lower end of the current scale. The lower the rate you get, the less money you’ll pay over the life of the loan, so it’s to your benefit to get the lowest rate possible.

What’s The Difference Between APR And Mortgage Rates?

The mortgage rate is the percentage of your mortgage balance you pay as a cost of borrowing the money. The APR measures the loan’s total cost, including the interest rate, origination fee, discount points, and other lender fees. Therefore, the APR is better when comparing loans from different lenders.

The Bottom Line

It’s time to determine how you can get the best rates possible. Improving your qualifying factors and monitoring market trends are the best ways. When you’re ready to start the home buying process, and see what rates you qualify for today.

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You can get a real, customizable mortgage solution based on your unique financial situation.