Key Concepts
- Mortgage rates are driven by investor demand
- Investors view mortgages as similar to bonds (lower risk, more stable return)
- Unpredictable consumer behavior makes mortgages more risky than “guaranteed” bonds like US Treasuries
- Investors expect higher rates of return for riskier scenarios (i.e. lower credit scores = higher mortgage rates, etc)
We’ve covered the building blocks of mortgage rates. Now let’s discuss where mortgage rates come from. How are they decided? Why can they change? Why can they be so different from person to person?
SIMPLE VERSION:
At their most basic level, mortgages are like bonds (fixed-income investments where an investor fronts a lump sum and is paid back over time with interest). There are many types of bonds in the bond market and those that are similar to each other tend to move in the same direction based on investor demand. Movement in the bond market generally translates to movement in mortgage rates.
From there, lenders make additional adjustments to rates based on things like credit scores, down-payment amounts and other risk factors. Those adjustments rarely change, so day to day movement in an individual rate quote is almost always determined solely by bond market movement (unless your credit score rapidly changes or you decide to put a different amount of money down).
DETAILED VERSION:
As discussed in our “What is a Mortgage?” article, the existence of mortgage rates depends on investor demand. At the simplest level, someone with money has to be interested in giving it to you so you can buy or refi a home and pay them back with interest over time.
Given that the investor could buy other investments (stocks, bonds, currencies, etc.) something about your mortgage has to get their attention. There are several pros and cons of investing in mortgages, but the most important factor is that mortgages offer a competitive rate of return without much more risk, compared to similar investments.
When we talk about similar investments, a mortgage would be most similar to a bond. A bond is considered a “fixed-income” investment because an investor pays a lump sum upfront in exchange for a fixed schedule of payments over time. Payments could occur monthly, semi-annually, etc.
Unlike most fixed-income investments, the borrower in the case of mortgages is a consumer. Contrast this to the biggest category of fixed-income borrowers: entire countries! For example, when it comes to US Treasury notes and bonds the borrower is the United States Treasury.
While the US and other major borrowers make debt payments for a guaranteed amount of time, consumers have choices when it comes to their mortgage. Consumers can CHOOSE to refinance or sell. That means the investment is retired. The investor gets their initial principal back and perhaps some of the interest they’re entitled to for the current month, but no further monthly payments. This could happen weeks, months, or years into a mortgage.
Other situations like foreclosure or short sale also prematurely end a mortgage. In some cases, the investor could lose some of their initial principal, but due to the structure of the mortgage market, that’s a rare occurrence these days. The unpredictable nature of consumers selling or refinancing is a much bigger issue.
Why would an investor care about getting their principal back early? Simply put, the investor is counting on making their money by collecting interest over time. In fact, investors often pay a premium for the right to collect monthly payments on a mortgage. If something cuts those payments short, the investor could LOSE money.
Here’s a practical example showing why an investor wouldn’t want to be paid back early:
$100,000 = Mortgage Loan Amount (principal)
$104,000 = What an investor might pay a mortgage company to obtain the loan
In this example the principal balance is still $100k. The investor paid a premium to obtain $100k of principal because the interest rate was attractive relative to other investment opportunities. The investor could have paid nothing for a loan with a substantially lower rate, but this rarely happens in the modern mortgage lending environment. Naturally, any time before the total amount of interest in the above example reaches $4k, the lender would like the borrower to continue making payments.
It’s worth noting that most mortgage transactions don’t simply involve one investor buying one mortgage. Investors will either buy lots of mortgages (so they are more likely to have plenty of mortgages remaining even if a few of them are paid back early), or they will simply buy a chunk of the same sort of portfolio. When multiple, similar mortgages are grouped together and sold off in those “chunks,” it’s a process known as securitization.
Continue Reading »Importance of Securitization and MBS
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FAQs
Interest rate movements are based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do interest rates. This is because there are more buyers, so sellers can command a better price, i.e. higher rates.
Why have mortgage rates gone up? ›
An increase in the base interest rate by the BoE makes borrowing more expensive for consumers and businesses. This, in turn, tends to reduce spending and borrowing, as individuals and companies become less inclined to take on new loans or financing. This decrease in spending helps cool down demand in the economy.
Why did my mortgage go up if I have a fixed-rate? ›
The part of your fixed-rate mortgage payment that changes annually is your escrow. Each year, the financial institution that holds your mortgage estimates how much you'll pay in property taxes and home insurance. If your home value has risen since the prior year, the cost of your taxes and insurance will also increase.
Why did mortgage rates go up today? ›
Why mortgage rates change every day. As seen in the mortgage rates chart above, mortgage rates go up and down daily. They move up or down according to what's happening in the broad economy: changes in inflation expectations, job creation and overall economic growth.
Will mortgage rates ever be 3 again? ›
It's possible that rates will one day go back down to 3%, though if current trends hold that's not likely to happen anytime soon.
Will mortgage rates ever go down again? ›
Mortgage rates are expected to decline later this year as the U.S. economy weakens, inflation slows and the Federal Reserve cuts interest rates. The 30-year fixed mortgage rate is expected to fall to the mid- to low-6% range through the end of 2024, potentially dipping into high-5% territory by early 2025.
Will the mortgage rates go down? ›
Mortgage rates began to go down in the latter half of 2023, as inflation dropped from 6.3% in September to 4.2% in December. In February this year, inflation dropped to 3.8% and is expected to meet its 2% target in the coming months.
Why did my mortgage go up $300 dollars? ›
A higher monthly mortgage payment doesn't necessarily mean you've done anything wrong. Mortgage payments can change even when the homeowner pays on time. Changes in your escrow account, property taxes, homeowners insurance or interest rate can increase the dollar amount of your mortgage loan payment.
Why did my escrow go up $400? ›
Why Did My Escrow Payment Go Up? Escrow payments usually go up due to increasing insurance costs or taxes. If you opt to add an escrow account later in your mortgage term, it may involve additional fees to set up and manage the account.
Why does my mortgage keep going up because of escrow shortage? ›
Two main factors can cause an escrow shortage—and ultimately increase your mortgage payments: Your property taxes increased from the previous year. Your homeowner's insurance premiums rose from the last year.
Yes, you should buy a house now if you're financially ready to do so. Here are the biggest reasons why that's the best move: If interest rates continue to drop, then house prices will start going up. Lots of folks haven't been able to afford a house because of high interest rates, so they've been sitting and waiting.
What is a good interest rate on a house? ›
As of Apr. 19, 2024, the average 30-year fixed mortgage rate is 7.50%, 20-year fixed mortgage rate is 7.39%, 15-year fixed mortgage rate is 6.89%, and 10-year fixed mortgage rate is 6.79%. Average rates for other loan types include 7.31% for an FHA 30-year fixed mortgage and 7.20% for a jumbo 30-year fixed mortgage.
Who is offering the lowest mortgage rates right now? ›
Best USDA mortgage rates
- Home Point Financial, 4.19%
- Freedom Mortgage, 4.21%
- Flagstar Bank, 4.28%
- Caliber Home Loans, 4.46%
- U.S. Bank, 4.54%
- AmeriHome Mortgage Company, 4.61%
- Pennymac, 4.67%
- NewRez, 4.68%
That means the mortgage rates will likely be in the 6% to 7% range for most of the year.” Mortgage Bankers Association (MBA). MBA's baseline forecast is for the 30-year fixed-rate mortgage to end 2024 at 6.1% and reach 5.5% at the end of 2025 as Treasury rates decline and the spread narrows.
How low will mortgage rates drop in 2025? ›
Here's where three experts predict mortgage rates are heading: Around 6% or below by Q1 2025: "Rates hit 8% towards the end of last year, and right now we are seeing rates closer to 6.875%," says Haymore. "By the first quarter of 2025, mortgage rates could potentially fall below the 6% threshold, or maybe even lower."
Will Fed interest rates go down in 2024? ›
When Will Interest Rates Go Down? We expect the Fed to start cutting rates beginning with the June 2024 meeting. The Fed will pivot to monetary easing as inflation falls back to its 2% target and the need to shore up economic growth becomes a top concern.
Will interest rates go down in 2024? ›
While it's difficult to predict how interest rates will change, in December 2023, the Fed predicted it would lower the federal funds rate to 4.6% by the end of 2024. Because its the rate banks charge each other to borrow money, the fed funds rate directly impacts the rate consumers pay.
Are rising mortgage rates bad? ›
When interest rates go up, mortgages become more expensive as the interest rate on mortgages also goes up. This makes it more costly for consumers to purchase a home. When homes are more expensive, the demand for them decreases.
How does raising interest rates affect inflation? ›
When the central bank increases interest rates, borrowing becomes more expensive. In this environment, both consumers and businesses might think twice about taking out loans for major purchases or investments. This slows down spending, typically lowering overall demand and hopefully reducing inflation.
Why do interest rates rise with inflation? ›
When inflation is high, there is a significant increase in prices of goods and services. Central banks usually increase their interest rates to tackle inflation and this influences interest rates charged by commercial banks on your loans.
