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The Different Factors That Determine the Rate on a Mortgage Tuesday, February 7th, 2012

There are many factors that determine the interest rate on your mortgage. Also understanding why rates move up and down each day is quite simple once you understand some basic economic fundamentals. The most frequently asked questions that buyers and homeowners ask are, What’s my rate” (even before an application is filled out), or “How is my mortgage rate determined” or “why is my rate higher than what is advertized on TV or radio? or “Do you see rates increasing when I am ready to buy in a few months?” , With these questions in mind, here is a guide to use that will help you better understand the different factors that will determine the interest rate on your home loan.

Your Credit Scores and Mortgage Rates

It is no secret that having good credit scores are important for buyers in this market to score the best rates, and this is especially true for conventional rates. For example, check out this chart below, a buyer with a 690 credit score purchasing a $400k home with 20% down, has to pay an additional 1.5 points ($4,800) to get the same rate as a buyer with a 740 score, or if they choose not to pay the points, instead they have to take a .375% higher interest rate (which will incorporate these points).

A buyer with a 660 score, has to pay 2.5 points to get the same rate as a 740 buyer, which amounts to $10k on a $400k loan. So having good scores is important to score the best rates on conventional financing.

To maintain great credit, everyone should review a copy of their credit report once a year, so when you are ready to get financing, this will ensure you are always in a position to score the best rates. As a California resident, you are entitled to a free report once a year.

I have a section on my website devoted to helping consumers and borrowers understand credit scoring. so they can improve their credit scores and get the best interest rates, see HERE to review this section.

Other Factors That Determine Your Mortgage Rate

There are several other factors that determine the interest rate on your loan. For example, the amount of equity you have in your home also decides what rate you get. Someone putting down 40% or a homeowner with 40% equity in their home, will get a lower rate than someone who puts down 20% or has 20% equity in their home, just like someone with 20% equity will get a lower rate than someone with 5% equity in their home.

The type of property you buy or own also determines the interest rate on your loan. For example, conventional financing will charge a higher rate for someone buying a condo with 20% down or less, than someone purchasing a single family residence home.

The loan amount you borrow will also effect your interest rate on your loan. Rates on loans <$417k, which is the conventional loan limit, will have a lower rate than a loan >$417k, which is considered a jumbo loan.

An investment property has a higher rate than a primary residence rate. Banks consider buying an investment property a higher risk than a primary residence, and price it accordingly. 20% is also the minimum down payment for an investment property purchase.

Borrowing cash out on your refinance will also affect your rate. For example, someone borrowing cash out to pay off some credit cards or home improvement, will usually always have a higher rate than a loan not taking any cash out.

As you can see, there are many different factors that have to be taken into consideration when determining the interest rate on your loan. There is not a one-rate-fits-all when it comes to obtaining the best interest rates on conventional financing.

What Economic Events Force Rates to Go Up or Down?

So what causes mortgage rates to go up or down? These are tied to some fundamental economic activities that take place everyday in our markets, by understanding these you will now be able to better predict and understand what direction rates will probably move.

The Federal Reserve…The #1 Reason Mortgage Rates Are So Low

The Federal reserve has been printing a lot of money over the past several years via their monetary stimulus program “Quantitative Easing”. They have been pumping this money into the markets to artificially suppress interest rates and kick-start the economy. It is fair to say it has worked as employment and housing is improving.

As you can see above, the influence of Federal Reserve stimulus on mortgage rates has been undoubted, and is the #1 reason why rates are so low in the first place. The average 30 year fixed rate prior to Federal Reserve stimulus was roughly 6.5%, compared to today’s rates around 4%.

Stocks and Bonds Compete for Investment Everyday

Stocks and Bonds compete everyday for investors dollars in the open markets, stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky.

Remember: When there is weak economic news (higher unemployment, less homes sold etc), this normally causes money to flow out of Stocks and into more stable Bonds, helping Bonds and mortgage rates improve.

But strong economic news (more employment and jobs created, more homes sold etc) normally has the opposite result, so investors will pull their money from bonds and put it into more risky stocks, thus causing mortgage rates to increase. It is an interesting dynamic that generally

good economic news is bad for mortgage rates!

The Relationship between Mortgage Bonds & Mortgage Rates, Why Rates can change 3 Times a Day.

The reason that mortgage rates move up or down every day, is because Mortgage Bonds (MBS) are traded everyday just like stocks. They either go up or down in price on a daily basis.

Here is a quick synopsis of how the mortgage bond market works, so you understand how rates are determined, and so you know when is the best time to lock in your rate.

See below a picture of a mortgage bond chart from April through August, from a mortgage bond trading company I subscribe too. This is where we watch mortgage bonds trade live each day, so we can give our borrowers up to the minute bond rate pricing, so they get to lock in the very best terms possible.

When you see these Bond prices moving higher, it means home loan rates are improving—and when they are moving lower, home loan rates are getting worse.   To go one step further—a red “candle” means that MBS worsened during the day, while a green “candle” means MBS improved during the day. As you can see below, between May and June mortgage bonds were trading downwards which meant rates were increasing, but mortgage bonds have been trading higher since July, so rates have been improving and moving lower again.

Depending on how dramatic the changes are on any given day, this can cause rates to change as much as 2-3 times throughout the day, as well as on the rate sheets we start with each morning. This daily trading of mortgage bonds directly correlates to the mortgage rates we see every day from lenders.

As bond markets are quite volatile these days, it is not unusual for mortgage rates to change 2 or 3 times in just one day. What this means is, the terms we quote in the morning may not be available in the afternoon if the mortgage bond market is trading negatively.

This is why shopping around can hurt consumers looking for the best rates, as the rates you were quoted on one day, may not be available the next day. Please keep this in mind when reviewing rates and deciding when to lock in.

Our goal is to always ensure that our buyers and homeowners get the best possible rates available in the market. My company is approved with 47 different banks and lenders, and this includes the top 5 best rate lenders in the nation, so we will always have the very best rates available in the market to offer our clients.

The impact of rising rates on buyer purchasing power

Changing mortgage rates do more to influence home affordability than changing home prices. When rates are moving higher, buyers lose purchasing power.

This chart below shows the “impact of rising rates on buyer purchasing power or affordability”. As you can see, when rates increase by just 1%, a buyer loses 10% in purchasing power or affordability. .

For example, see how the payment at the 3.5% rate on a $400k loan, is roughly the same payment as the 4.5% loan at $360k, a loss of 10% in purchasing power for a buyer .

This is a great chart for buyers to review, as it shows how just a small increase in rates can eat into their purchasing power or affordability

A Look at Mortgage Rates Over the Past 40 Years

This chart below puts current mortgage rates in perspective. Today’s mortgage rates are a gift and should be taken advantage of  by anyone looking to borrow money to finance a home. The cost of borrowing money is on sale, so it is a great time to get financing to purchase a home or refinance

As you can see below, the average 30 year fixed mortgage rate over the past 40 years is roughly 8.7%, and 6.5% over the past decade. So for any buyers or people looking to refinance who are still on the fence, a rate near or below 4% is still a terrific mortgage rate.

There are many homeowners with 30 year mortgages who are switching to shorter term loans. According to Freddie Mac, over the last quarter approximately 40% of U.S. households who did a refinance, refinanced out of the popular 30-year fixed rate mortgage, in favor of shorter loan terms offered by 15-year, 20-year and 25-year fixed-rate loans  (see chart below). Low mortgage rates have been a catalyst.

At today’s rates, homeowners with a 15-year loan term will pay 64% less mortgage interest than with a comparable 30-year loan,  as a 15-year mortgage requires just $28,000 of mortgage interest per $100,000 borrowed. Whereas 30-year loans pay $81,000 per hundred-thousand dollars borrowed.

As the payment on a 15 year mortgage is quite often too expensive for many borrowers to pay each month,a 20 year or 25 year fixed is also a great way to save interest over the term of a loan. as a 25 and 20 year payment is more affordable.

We can even help homeowners refinance into a 27 or 23 year fixed for example. This is a great option for someone who has been paying on their 30-year mortgage for a few years, but do not want to start the loan back on a 30 year term. This is called the “Flexible Loan Term ” program, you can Click HERE  for more information.

If you would like to see if a shorter term mortgage would be a good fit for you, just let me know and I can run the numbers for you. If you have any questions about interest rates or getting approved for financing, please feel free to contact me directly at 858-442-2686

Category: Credit

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