How Mortgage Rates Are Determined

February 3, 2010 by  
Filed under Mortgage Updates

You are ready to buy a home and now are looking at obtaining a mortgage. As you begin your research you are most likely educating yourself on how mortgage rates are set and what causes them to change.

There are a number of reasons mortgage rates go up and down. The first is Bond Prices. Mortgage rates are backed by mortgage securities, which are also bonds. Mortgage rates will decrease if the price of a bond increases, enabling the banks to sell them at a high price. When bond rates sell at a lower price, mortgage rates will, in turn, increase. Whether a bond’s value is high or low can depend on many things. One influence can be the cost of stocks. Stocks and bonds compete for the same investment dollar on a daily basis and because there is only so much money people will invest, people with either choose the stock or the bond.

Another influence can be the Federal Reserve. When the Federal Reserve feels that interest rates need to be decreased in an effort to stimulate the economy, this reduction in rates can often cause a stock market rally. When the market becomes bullish, the money to invest in stocks comes from the selling of mortgage-backed securities. This isn’t to say The Federal Reserve is a primary indicator of mortgage rates. The Federal Reserve typically affects short-term interest rate maturities, the Fed Funds rate, and the Overnight Lending rate. These factors have a direct impact on the Prime rate. If you took only this into consideration, you may mistakenly conclude that changes made by the Feds will cause a similar movement in mortgage interest rates. However, mortgage interest rates are dictated by the trading of bonds or mortgage-backed securities, which trade on a daily basis.

Supply and Demand is another large factor in not only the cost of a home but also in the value of a mortgage. The price of almost everything is often determined by supply and demand. If there is a high demand for homes typically interest rates will increase based on the demand for credit. If there is a low demand for credit then interest rates will decrease. Supply and demand is often affected by national financial trends.

Banking Costs also affect mortgage rates. COFI or Cost Of Funds Index determines how much interest banks have to pay on sources of money such as savings accounts or CDs. If bank rates increase or the cost at which they can loan money, so do mortgage rates. If it is lowered, banks can pass on this discount. COFI is often determined by national and international economic conditions.

The ways people keep their money in banks can also be behind COFI interest rate changes as well; if fewer people put their money in savings accounts, which generally pay little interest, and place more money in higher-paying Certificates of Deposit, mortgage rates may increase because of the higher interest cost being paid to account holders.

There are many reasons mortgage rates can drop, all stemming from a few core influences. Typically it is not just one more two events but a number of factors that come in combinations of many direct and indirect economic factors and indexes which they influence.

  • Winsor Pilates


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