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March 23, 2016

Where Do Mortgage Rates Come From?

Mortgage rates are life-changing numbers. If the rate on a thirty year $290,000 loan were to drop from just four to three percent, it would save the customer $170 per month, and $61,200 throughout the life of the loan. To the first-time homebuyer, it may feel like understanding these crucial numbers is for the Las Vegas oddsmakers. It really isn’t that complicated though.  

A jumble of factors go into determining an interest rate, but just a handful rise above the rest in importance.

  1. The Economy
    The easiest way to anticipate mortgage rates is to simply observe the economy. Rates are meant to be custom designed for what borrowers can afford on that day, which makes rates a catch-22. The higher mortgage rates go, the more bullish the economy is. When mortgage rates are low, it means times are tough. Rates have been rising over the past two weeks (although they remain historically low), primarily due to a rebounding stock market and a low unemployment rate.
  2. The 10-Year Treasury
    The movement of the 10-year Treasury bond yield is said to be the best indicator to determine whether mortgage rates will rise or fall. But why?Though most mortgages are packaged as thirty-year products, the average mortgage is paid off or refinanced within ten years. So the ten-year bond is a great bellwether to measure interest-rate change. Treasuries are also backed by the “full faith and credit” of the United States, making them the benchmark for many other bonds as well.Additionally, 10-year Treasury bonds, also known as intermediate-term bonds, and long-term fixed mortgages, which are packaged into mortgage-backed securities (MBS), compete for the same investors because they are fairly similar financial instruments.However, treasuries are 100 percent guaranteed to be paid back, while mortgage-backed securities are not, for reasons such as payment default and early repayment, and thus carry more risk and must be priced higher to compensate. 

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  3. Investors
    Another great hint to determine where mortgage rates are going is to follow the investors. If times are good, people invest in higher-risk, higher-yield stocks. When the economy is sluggish, investors typically favor real estate, which is less risky and can even be immune to certain economic downtimes. Remember, a bullish stock market means higher mortgage rates. 
  4. Property Type
    Homes are either bought to live in, or to rent out. In the case of a purchase, if you are buying an investment property the rate is typically higher to account for the additional layer of risk. Why? Most people rely on rental income to cover the cost of a mortgage. If a renter fails to pay, or disrespects the property, the owner’s ability to afford the property may change. When buying a home that the buyer intends to live in, there is almost no difference in rate. The same goes for vacation homes.
  5.  You
    Every borrower carries risk. Risky borrowers, at least in the eyes of prospective lenders, must pay higher rates. Things like a poor credit score and a small down payment could lead to a higher rate, whereas borrowers with stellar credit and plenty of assets will have access to the lowest rates available. One way for borrowers to decrease the risk they present is offer a larger down payment. Even a medium risk borrower (someone with a credit score from 600-660), can see a significant improvement in rate with just a slightly larger down payment. A borrower with average credit could drop their rate by as much as .375% just by putting an extra 5% down. That’s over $20,000 over the life of the loan in the scenario mentioned earlier.

Of course, there are a slew of other factors and variables that can alter a mortgage rate, from the Fed, to mortgage points, to timing. Even Fannie Mae, Freddie Mac, and the Mortgage Bankers Association have differing, though similar views of where mortgage rates will go for the rest of 2016. However, understanding the few major factors that go into mortgage rates can turn a first-time homebuyer into an educated homebuyer.

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