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Mortgage rates greatly affect how much you can afford to borrow and, ultimately, how much house you can afford. The best rates are for borrowers with excellent credit, great income, and only a few debts.
But there are factors outside of your personal situation that affect mortgage rates. The economic conditions determine the rates banks have to work with, and then they adjust those rates according to your qualifying factors. It’s a big puzzle filled with many pieces to determine the right interest rate, but knowing all the factors that affect what you can get helps you understand the mortgage rate process.
Check out the factors affecting the mortgage rates lenders offer to determine the right time to purchase or refinance a home.
Inflation
Inflation is a big part of why we’ve seen such higher interest rates over the last year compared to during the pandemic.
When inflation increases, the purchasing power of the dollar decreases. In short, purchasing the same items takes much more money than when inflation rates were lower. We’ve all seen this at the grocery store, gas pump, and other everyday purchases.
Inflation also affects mortgage rates, even though it does not directly affect them. With higher inflation rates, profits decrease for lenders. For example, if they charge a 5% interest rate, but inflation is 3%, they only see a 2% profit, not the 5% you think they’re getting.
High inflation rates also cause investors to demand a higher return on mortgage-backed securities, causing interest rates to increase. Without investors, lenders wouldn’t have much liquidity and couldn’t fund as many loans.
Economic Stability or Growth
When the economy does well, mortgage rates tend to increase. This may seem somewhat backward, but it goes back to the theory of supply and demand.
When there is a large demand for something, such as mortgage loans, interest rates must increase to keep up with demand. If rates were low enough that everyone could afford them, banks would run out of capital, and we would have a different problem.
With higher demand, lenders don’t need to offer lower rates to lure in borrowers. The demand is there, and lenders need to be picky about who they lend to, which they do naturally by increasing interest rates.
When the economy declines, interest rates decrease, too. This occurs because of the lack of demand for mortgage loans when the economy is less than stable. When unemployment rates increase, fewer people are in the market to buy a home. More people buckle down and stop spending. This prompts mortgage lenders to decrease rates to lure in more borrowers.
The Bond Market
Mortgage-backed securities, which are the investments lenders sell on the secondary market to increase their liquidity, have one major competitor – the bond market.
Investors can purchase fixed-rate government and corporate bonds with a much lower risk level than mortgage-backed securities. For investors to take the risk, the yield on MBSs must be much higher than what’s offered in competing investments.
Many lenders use the 10-year Treasury Bond yield as a benchmark. They try to keep their interest rates above this benchmark to make MBSs more attractive to investors.
Typically, when bond interest rates increase, so do mortgage rates, and vice versa. Higher bond interest rates make current bonds less valuable and mortgage-backed securities more enticing.
Of course, you can’t control the bond market or how it affects mortgage rates. But you can control where you get a mortgage and the factors you bring to the table that influence what a mortgage lender offers you.
The Federal Reserve’s Monetary Decisions
The Federal Reserve, or the Fed as you often hear them called, doesn’t directly affect mortgage rates, but their decisions almost always cause mortgage rates to go one way or the other.
The Fed controls the federal funds rate or the short-term interest rate banks pay for overnight loans, which is how they get their capital. When the Fed increases the rate, it is more expensive for banks and lenders to operate. To stay in business, they must increase the rates they charge consumers so they still make a profit, and vice versa.
When you hear on the news that the Fed raised the rate, it doesn’t mean mortgage rates will skyrocket overnight. However, it is a sign that they may change in the near future, increasing from what they are currently.
The Fed generally meets eight times a year, but there are times when they have emergency meetings to handle unexpected financial issues.
The Overall Housing Market
Of course, the overall housing market is an obvious factor in mortgage rates. This goes back to the supply and demand theory. The more demand for housing, the higher the interest rates will go, and the opposite is true when demand falls.
You’ll often hear the housing market in terms of a buyer’s or seller’s market. In a buyer’s market, there are more homes on the market than demand to buy them. This gives buyers the upper hand, allowing them to negotiate more than they would in a seller’s market.
In a seller’s market, there are more buyers than homes available. This often causes home prices to increase because there is more demand for the same house, leading to a bidding war. Higher demand can often lead to higher interest rates, but this isn’t an overnight change.
Factors You Can Control With Interest Rates
Economic factors play an important role in mortgage rates, and there is nothing you can do to control them.
However, there are certain factors you can control to ensure you get the lowest rate possible of the available mortgage rates at the time. Lenders look for borrowers who are the least risky and the most likely to make their payments.
To present yourself as a non-risky borrower, consider the following:
- Credit scores: The better your credit history and score, the better interest rates lenders can offer. Ideally, you should have a credit score of 680+, but you can still secure financing with a lower score. The key is to have a good payment history and a low amount of outstanding debt compared to your available credit lines.
- Debt-to-income ratio: Your DTI compares your outstanding debts to your income before taxes or gross income. Lenders look for DTIs of 43% or less to reduce the risk of non-payment. Try paying your debts down or off before applying for a loan to keep your DTI low and increase your chances of securing a lower interest rate.
- Stable income: Lenders want borrowers with stable income because this reduces the risk of non-payment. Having at least a 2-year job history at the same job with stable income will increase your chances of getting a lower rate. If you change jobs but stay within the same industry or show that you have the training/education to succeed, it may still work in your favor for lower rates.
As you can see, there are many factors you can control to get the lowest rates possible. The key is presenting yourself as a low-risk borrower. Even though there is collateral in the property, lenders are not in the business of owning homes. They would prefer borrowers who make their payments on time, so they don’t have to use their resources to repossess and sell properties.
You don’t have to be a ‘perfect’ borrower to secure a loan, but the better qualifications you give a lender, the lower the interest rates lenders provide. Interest rates are directly affected by your risk. The more risk you pose, such as a low credit score, small down payment, or a high debt-to-income ratio, the higher lenders will push your interest rate to compensate for the risk.
Final Thoughts
Mortgage rates aren’t the only factor you should consider when purchasing a home, but they are a considerable factor. The lower the rate you can get, the less your mortgage costs, and the less you pay for the loan overall.
Knowing the current market and what lenders can offer can help you determine if it’s the right time. Of course, perfecting your personal factors as much as possible in any market environment will ensure you get the best mortgage rates possible.
