How Mortgage Rates Are Calculated
Most people are not interested in the mortgage market unless they are planning to refinance or purchase a home. If you do not know much about the mortgage market, it can at times seem like the mortgage rates are entirely based on mysticism. Nevertheless, the primary goal here is to help you understand exactly how these rates are calculated. Mortgage rates are calculated based on several market factors, for instance, the general economic health and personal factors like your credit score, how you occupy the property, and the size of the loan in relation to the property’s value.
Before any personal factors are considered when calculating the mortgage rates, several market factors play a role in its determination. These factors include the Federal Reserve, the bond market, and the status of the whole economy.
The Bond Market
When people purchase mortgage bonds, the mortgage rates tend to reduce. This is because the current rate of the original mortgage bond does not have to be high to attract investors. On the other hand, if investors are dumping mortgage bonds on the market, the mortgage rates will increase as an enticement for potential investors to buy these bonds.
The Federal Reserve
The Federal Reserve controls the amount of money that banks can borrow from each other, thus controlling the money supply. In case the short-term interest rates are low, the borrowing cost is low, which will increase the money supply and drive the prices up. On the other hand, if the interest rates are high, there is less money in the market, and the prices will go down.
If investors believe we are in a prosperous time, they will move their money from bonds into stocks for the chance of a higher return, and thus the mortgage rates will increase. In case the investors believe that we are headed into a financial crisis, they will move their money into bonds, and the mortgage rates will drop.
The higher your credit score, the lower your mortgage rates may be. If you have a bad credit score, you will be seen as a high-risk borrower, and thus you will get a higher mortgage rate.
The higher your down payment, the less the lender will have to lend, reducing the risk associated with the transaction. If you have a down payment of less than 20 percent, mortgage insurance is needed when you take on conventional loans. You can go for borrower-paid mortgage insurance, which will include lender-paid mortgage insurance or a monthly fee. In case you choose the former, you will end up with a bigger mortgage payment.
How you plan to occupy the property also affects the mortgage rate. You will get the lowest possible rate on a primary property, while the rates will be higher for a vacation home and slightly higher for an investment property.
If you are looking to convert your home equity into cash, you may get a higher rate than if you were looking to purchase a home or to refinance exclusively to reduce your interest rates or change your terms. This is because you will be taking on a bigger balance than what you had, which brings more risk for mortgage investors and lenders.
Why Mortgage Rates Matter
A small difference of 1 percent may not look significant, even when you are comparing monthly mortgage payments on a modest loan figure; however, the additional amount that you will end up paying in the form of interest is astounding over the life of the mortgage. The bigger the loan amount, the higher the interest that you will pay. Therefore, being able to qualify for a lower mortgage rate will keep your monthly payments lower and may allow you to save tens of thousands of dollars in the form of interest over the lifetime of your mortgage.
Contact us with any mortgage questions you may have.