How Are Current Mortgage Rates Determined?

If you were to look at mortgage interest rates being offered by 10 different banks or mortgage companies, you would quickly discover that most are different.  Although the level of difference may not be significant, the rates typically vary.  Many people, especially first time homebuyers are curious why current mortgage rates vary and what the process is for them being determined in the first place.  In this article, we will address we will provide clarification.

If you were to look at mortgage interest rates being offered by 10 different banks or mortgage companies, you would quickly discover that most are different.  Although the level of difference may not be significant, the rates typically vary.  Many people, especially first time homebuyers are curious why current mortgage rates vary and what the process is for them being determined in the first place.  In this article, we will address we will provide clarification.

If you look back to Biblical times, the Law of Moses in Israel prohibited interest to be charged on any personal loan and in the Middle Ages property was thought to belong to God so charging interest meant asking God for money.  Even in the ancient Catholic Church charging interest was considered a sin although many people did it anyway.  Over time, this “law” of not charging interest on a loan faded.  By 1847, the French Central Bank was the first financial institution in the world to try to control interest through manipulation of the country’s money supply.

Today, banks, credit unions, and mortgage companies actually use different systems and criteria for setting interest on all consumer loans.  Whether for a car loan, boat loan, motorcycle loan, personal loan, business loan home equity loan, or mortgage loan, lenders are unique in the way interest is determined.  This is why as you look at options for a mortgage loan you would find so many variations as to the interest being charged.

For starters, the majority of mortgage loans are written with both documentation and terms.  Because of this, loans of this type can be sold into the secondary market.  Included in this market are different companies and organizations to include Freddie Mac, Fannie Mae, and a number of other mortgage buyers.  With this market, interest rate set is unique to the actual type of loan.  In other words, secondary markets can set one rate for a first time buyer loan, a home equity loan, and 30-year Fixed Rate Mortgage loan, a 15-year Adjustable Rate Mortgage loan, and so on.

Typically, if a mortgage is written for sale in the secondary market, the primary concerns is what the financial institution or mortgage company is paying out on savings accounts, which is also referred to as the “cost of funds.”  As a result, most mortgage interest rates today are based on competition, meaning the market is what controls interest charged.  If a bank or mortgage company wanted to add new loans, interest charged would likely be somewhat less than the competition, as a way of drawing the attention of new customers.  On the other hand, if making greater profit is the primary goal then interest might be set higher than the competition.

Another factor that plays into the way current mortgage interest rates are determined has to do with the financial institution or mortgage lender’s credit policy.  Every lender has its own rules and regulations.  Sometimes, these requirements are directly linked to what the government allows while other times, they are simply the standard operating procedure established by the Board of Directors or shareholders.  In this case, if the goal is to add new loans, the standards for setting interest might be loosened but often, anyone applying for a mortgage loan with less than perfect credit would be considered a risk, which means interest would be higher.

In summary, what happens is that banks, credit unions, and mortgage companies will have a baseline rate, which comes from the United States Treasury Department.  From there, the lending rate for a mortgage loan is marked up based on the factors mentioned above such as competition and internal policy.  Typically, lenders have a range of rates that includes a low and high end.  If your credit score were less than perfect, you would be charged a higher interest rate whereas if your credit were excellent, you would be rewarded by being able to secure a mortgage loan with low interest.  For this reason, maintaining good credit is to your advantage, not only from the perspective of getting low interest on a mortgage loan but also having more buying power.