Changes in mortgage rates are an important factor in our decision to purchase houses or refinance existing mortgages.
It makes us wonder, what really causes the mortgage rates to rise or fall?
Well, there are several factors which impact mortgage rates.
In general, a growing economy leads to higher mortgage rates while a slowing economy leads to lower mortgage rates.
This is evident from looking at past recession data (shaded in grey) in the graph below:
While that is generally true, there are plenty of factors that cause the mortgage rates to rise or fall. Let’s discuss each of these in detail one by one.
One factor impacting mortgage rates in the United States is the Federal Reserve Board’s macroeconomic policy response to changing macroeconomic conditions.
Federal Reserve's monetary policy objectives include:
(1) Maximum employment, which means all Americans that want to work are gainfully employed, and
(2) Stable prices for the goods and services we all purchase.
The Federal Open Market Committee (FOMC) is the branch of the Federal Reserve Board that determines the direction of monetary policy specifically by directing open market operations.
One of the tasks FOMC performs is setting the Federal Funds Rate: the target interest rate at which commercial banks borrow and lend their excess reserves to each other overnight.
In an economic recession, FOMC typically lowers the Fed Fund Rate, correlating with mortgage rates to drop.
On the other hand, in a growing economy, FOMC sets a higher target Fed Fund Rate, which often correlates with higher mortgage rates for home buyers.
Another factor that affects mortgage rates is availability of credit.
Based on macroeconomic conditions like prevailing unemployment levels, mortgage lenders may project an elevated risk of credit default.
In anticipation of higher rate of credit default, lenders may tighten their underwriting guidelines. They might outright stop offering specific mortgage programs like Jumbo Loans or FHA mortgages, or price themselves out of the market, i.e. setting outrageously high rates for specific products.
Recall that so long as all usury limits and anti-discriminatory laws are followed, mortgage lenders are well within their rights to set underwriting guidelines for their specific mortgage products and change the cost of their offered product any day.
Another important factor impacting rates is processing capacity constraints at mortgage lenders.
When lenders are capacity constrained because of too many applications to review in their system, they may be simply unable to process enough application in time, and may opt to raise interest rates.
Note that mortgage lenders are free to set any rate they like within usury limits, so long as they are in full compliance with the Equal Credit Opportunity Act and are not discriminating against a borrower.
As a reason, on any given day, different lenders actually price the risk of a given borrower and a given property very differently. The rates offered by different lenders to a borrower vary significantly.
This is in part driven by strategic interests of mortgage lenders and also their current lending portfolio. Lender’s freedom to set arbitrary rates within usury limits impacts borrowers significantly and makes shopping for mortgage rates a key step for mortgage seekers.
The rates offered by different lenders to a borrower vary significantly. Click To Tweet
Reducing mortgage payments is a key step to financial freedom. While we can’t provide financial advice, in a low mortgage rate environment, one can review with their financial advisor if refinancing can help them reduce their mortgage payments and the overall debt burden.
Every refinance has an associated closing cost. It would make sense to refinance only if the net tangible benefit of the refinance outweighs the closing costs.
In summary, there are multiple factors that can impact an individual’s best available interest rate. These include: Macroeconomic Conditions: Fed Fund Rate, Credit Availability and Lender Processing Capacity Constraints.
In all cases though, it is highly advantageous to explore different options with a mortgage broker, insist on a loan estimate and select the option that works best for you. Schedule a consultation or apply today to review your mortgage options.
