everything about mortgage rates

You want to get the lowest mortgage interest rate.

Of course you do.  Who doesn’t!?

I can help you do that.

But what you might come to realize is that the interest rate may not be the most important factor.

What!?  That’s right interest rates are very important and getting a lower rate could save you tens of thousands of dollars over time but just focusing on interest rate could also cost you thousands of dollars.

Everything you ever wanted to know about mortgage interest rates can be found in this guide. Click To Tweet

Understanding how the market works will help you to secure the best rate possible.

So let’s get started…

Now or Later

now or later

Let’s play a game…

Imagine you won the lottery and you had two options.  Would you rather have $1,000 now or $100.00 every month for the next 30 years?

What if I told you that the $100 monthly payday could stop at any time?

When an investor buys a mortgage they are betting on the long-game.  They are betting that the person paying the mortgage (the borrower) will continue to do so long enough that they receive more money from monthly payments due to the interest.

What would stop the borrower from keeping their mortgage?

  • Sell their home
  • Refinance their home
  • Paying off the balance (lottery, maybe?)
  • Financial trouble (unable to make payments)

Let’s go back to the example I provided above.  If you paid someone $1,000 in return for $100/mo payments you need those payments to continue for at least 10 months to break even ($1,000/$100).  But that is just to break even.

If you are going to play the long-game you don’t want to just break even.  You want to make more, right!?

The game that mortgage investors like Fannie Mae and Freddie Mac play is guessing at how long people will pay their mortgages and how to avoid people from defaulting on their mortgage.  And they’ve gotten pretty good at it which has paid off big.

Sellers of mortgages (mortgage companies like the one I work for), on the other hand, don’t want to play the long-game.  Instead they prefer the short-game of providing mortgages directly to people like you and me with the plan to sell the mortgage after closing.

When they sell a mortgage they free up the cash to lend to someone else and generate an income or profit to their business.

Mortgage Rates and Treasury Bonds

treasury bondsWhere is the safest place you can invest your money?

safe

In a safe, right?

If you didn’t want to put all your cash into a safe and you wanted a better rate of return than a typical checking or savings account will provide the safest, most secure investment you can get is a Treasury Bond backed and guaranteed by the United States Government.

Treasury Bonds are a loan to the government for a period of time of 10 or 30 years set a fixed rate of return.

Sounds familiar, right?  Kinda like a mortgage?  Fixed rate loan over a period of time, say 15 or 30 years?  Exactly!

When investors are looking for somewhere to invest they generally look at investments in terms of risk and return.  Investors bucket low risk investments together.  Here are a few low risk investments available:

  • Certificates of Deposit (CDs)
  • Money Market Accounts
  • Treasury Bonds
  • Mortgage Backed Securities

Mortgages are not sold one by one but rather in pools of loans called Mortgage Backed Securities (MBS).  Mortgage Backed Securities are bought and sold similarly to stocks or bonds.

Since Treasury Bonds and MBSs are attractive to the same type of investor the price for such investments are directly related.

Stocks and Bonds

Why do people buy stocks over bonds?  The possible rate of return.
Why do people buy bonds over stocks?  Security.

What happens to the stock market when the economy is doing well?  It goes up.
But if the economy is not doing well the stock market goes down.

How about bonds?  Well, they go in exactly the opposite direction.  When the stock market is going down investors turn to more secure investments where they can get a guaranteed rate of return (rather than a loss).

So, if the stock market is going up, the price of bonds goes down.

stocks vs bonds source: tradingeconomics.com

When prices on bonds go down the yield (rate of return) on those bonds go up.

Eeeerp…wait, what?

I don’t know about you but this concept is a bit hard to get your head around.  I had to look at this for a while to understand so let me explain it the best way I can.

If the demand for bonds is down that means that the price will go down.  Just like anything, right?  If a grocery store has a supply of apples but no one is buying them they will put them on sale, dropping the price, which will encourage more people to buy.

So far, so good.

Now, did you get a smaller than normal apple?  No, it was the same size as the full-priced apple.  Which means you yielded more for the price you paid.  Same thing happens with the bonds, you paid less for the bond because the demand was not there but you still got the same product.

Let’s recap real quick.  Stocks go up.  Treasury Bonds go down.  Treasury Bond yield goes up.  Ok, great.

If the yield on the bond is going up that means similar investments, like Mortgage Backed Securities, will do the same thing to attract the same type of investor.  In other words, in the scenario, mortgage rates would go up.

Stocks go up. Treasury Bonds go down. Treasury Bond yield goes up. Mortgage rates go up. Click To Tweet

And we can look at it from the exact opposite side:
Stocks go down.  Treasury Bonds go up.  Treasury Bond yield goes down.  Mortgage rates go down.

In other words, mortgage rates (blue line) and Treasury Bonds (purple) are directly related as you can see here:

mortgage rates vs treasury bonds

Wait a Second!  What About the Fed Funds Rate?

I’m sure you have heard about the “Fed” who has recently been increasing “rates”.

Who is this “Fed” anyway?  And what “rates” are they increasing?

The “Fed” is the Federal Open Market Committee (FOMC) which is the monetary policy arm of the Federal Reserve System, the central bank of the United States.

The FOMC sets a federal funds rate which is a target rate.  This is the rate they would like banks to lend money to other banks overnight.  To hit that targeted rate they take action in the market either buying or selling Treasury Bonds.

When the demand on bonds goes up or down, what happens?  If you recall from earlier, the demand on bonds impacts prices which impacts yields which eventually impacts mortgage rates.

The key word here is eventually.

Let’s look at a quick example.  The Fed looks at the economy and feels that it is in bad shape.  What do they do?  They set a lower federal funds rate.  They go out in the market and buy bonds.  By buying bonds they flood the market with cash reducing the cost to borrow money.  People use the cash and low cost to borrow to buy things.  When people buy things companies make money, the economy improves and the stock market increases.

But what happened to bonds?  The demand for bonds went up…which increased the prices, which decreased the yeild and mortgage rates went down.

BUT WAIT!

Fed set a lower target rate which increased the stock market.  And we know when the stock market increases, mortgage rates go up.
But the Fed bought bonds which increased Treasury Bond prices which caused mortgage rates to go down.

Confused?

Here is what happens historically…

When the Fed lowers rates the stock market quickly increases, pushing mortgage rates up but eventually they decrease over time. Click To Tweet

mortgage rates vs the fed source: tradingeconomics.com

Factors that impact your rate

mortgage rate factorsAlright, enough with all the stuff out of our control.  What are the factors mortgage companies look at when quoting interest rates?

Mortgage companies look at risk.  The risk of someone defaulting on a mortgage?  Over time the mortgage industry has determined what causes defaults and here are the main factors (hover for additional info):

Loan Type

Generally, Conventional mortgages have higher rates compared to FHA, VA and USDA.

Loan Term

The shorter the loan term (10, 15, 20, 25, or 30 years) the lower the mortgage rate will be.

Loan Amount

When the loan amount is too high or too low your interest rate can increase.

Loan-to-value (LTV)

Reducing LTV may decrease your rate but something strange happens at 20% down.

Purchase or Refi

Purchases have the lowest rates, followed by rate & term refinances and lastly cash-out refinances.

Occupancy

Primary residences have the lowest rates, then 2nd homes and finally investment properties.

Fixed or Adjustable

Adjustable rate mortgages normally have a lower rate (if not, don’t get one).​

Lock Period

Locking guarantees that rate for a period of time. The longer the lock the higher the rate.

Mortgage Insurance

You can avoid monthly MI through lender-paid MI (LPMI) by increasing your rate.

Assistance Programs

Down payment assistance programs may result in an increased interest rate.

Escrow Account

If you pay taxes and insurance yourself some loans allow this but at a cost to your rate.

Property Type

Single Family Homes have the best rates, then PUDs, condos.

Credit Score

Credit score is one of the biggest factors. The lower your score the higher your rate.

Credit History

Past foreclosures or bankruptcies can negatively impact your rate.

Debt Ratio

Having a high debt ratio (debts dvided by income) may result in a higher interest rate.

Reserves

More money available after closing (reserves) may reduce your rate.

How to Get the Best Rate

The best rate can be achieved by taking each of those factors and making all of them the best possible.  For example:

  • Purchase
  • Single Family Home
  • Adjustable Rate Mortgage
  • 740+ Credit Score
  • 25%+ Down Payment
  • Lock for Short Time
  • Low Debt Ratio
  • High Reserves

But is this realistic?  No.  At least not for 99% of us.

Instead the focus should be on looking at your unique situation and looking for the small tweaks that can help you achieve a better rate while making sure you have the right loan program.

Interest Rate Isn’t Everything

balance - mortgage rate isnt everythingWith all this focus on the interest rate you might think that rates are the most important factor when it comes to the cost of your mortgage.

Interest rates, although important, should not be your primary focus when designing your mortgage.
The combination of loan program, mortgage insurance, closing costs and interest rate is what matters most, not just the rate. Click To Tweet

For example, you could call me and ask me what the lowest rate I could offer you would be.  I may say 2% but that rate would cost you so much money at closing it wouldn’t be worth it.

It’s a Balancing Act

The key when designing a mortgage strategy is to keep things in balance:

  • FHA or Conventional?
  • What is important: now (low closing costs) or later (low rate)?
  • More money down or pay off debt?
  • Monthly mortgage insurance or lender-paid mortgage insurance?

Then there are other considerations outside of the mortgage strategy itself which is maximizing all the interest rate factors specific to you.

One example would be to use some money you have saved to pay off debt which could reduce your credit utilization ratio, which could improve your credit score.  If you were able to increase your score from a 704 to a 722 credit score, as an example, that could mean saving you thousands of dollars.

This is where a Mortgage Advisor with a holistic view of your situation can advise and direct you down the right, most beneficial path for you.

A professional Mortgage Advisor, like those with The Wynn Team at Citywide Home Loans, can help you in navigating the complex world of mortgage financing, loan programs, mortgage insurance, closing costs and interest rates to design a mortgage strategy that not only meets your short-term needs but also your long-term financial goals.

My hope in providing this information is to help you avoid getting into the trap of focusing your attention solely on interest rates without regard to other factors that could increase your cost over time.

Do you have a question about interest rates I didn’t cover?  Leave a comment and I will make sure to get you an answer.

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