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What determines mortgage rates? It’s complicated.

Yahoo Personal Finance· Getty Images
Laura Gariepy
Updated 12 min read

Many factors impact the cost of owning a home, such as your mortgage principal, property tax bill, homeowners insurance premium, and — this is a big one — your mortgage interest rate. We’ll discuss what determines mortgage rates. That way, you can better understand the details you can’t control and tackle the ones you can.

Learn more: PITI (principal, interest, taxes, insurance) and how it affects your mortgage

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Your mortgage interest rate is the price your lender charges to issue your home loan. “Mortgage interest rates are really important for home buyers because they directly affect how much you pay each month,” said Jeanine Thomas, founder and president of Sarasota Mortgage Group LLC via email. “When rates are lower, your monthly payment is less, which makes buying a home more affordable for you.”

Suppose you buy a $500,000 house, put $100,000 down, and finance the remaining $400,000 with a 30-year fixed-rate mortgage. Here’s what your monthly mortgage payment would look like at three different interest rates:

Please note: The above figures only represent mortgage principal and interest payments and don’t include property taxes, homeowners insurance premiums, or other related costs.

As you can see, your rate significantly impacts your monthly housing bill. Plus, if you keep your mortgage for the entire term, a higher rate can cost you tens or hundreds of thousands of dollars more over the life of the loan.

Mortgage interest rates are constantly in flux and can change multiple times daily. Here’s a snapshot of the last several years, including the interest Freddie Mac listed for the beginning of each month:

While today’s rate is significantly higher than the all-time lows of four years ago during the peak of the COVID-19 pandemic, it’s nowhere near the historic peak of 18.63%, which impacted borrowers in October 1981. Rates have obviously come down since then, and government-sponsored enterprise Fannie Mae predicts they will continue to decrease slowly over the coming year. However, most home buyers should expect to pay more than 6% through 2025.

Dig deeper: When will mortgage rates go down? A look at 2024 and 2025.

Several external factors influence mortgage rates. You can’t control these components, but understanding them can help you grasp why rates are trending a certain way and know how they could change in the future. Let’s take a look at some of the major issues that affect mortgage rates.

“When the federal funds rate — what banks charge each other for overnight loans — goes up, mortgage interest rates generally follow suit,” said Thomas. “This pattern holds true for [benchmark interest rates like] the Secured Overnight Financing Rate and the Constant Maturity Treasury rate as well.”

Although the federal funds rate doesn’t directly impact mortgage rates, the two are correlated. If the Federal Reserve cuts the federal funds rate (or even if investors expect the Fed to slash the rate soon), you can expect mortgage rates to drop too.

The Fed cut the rate by half a point at its September 18, 2024 meeting. The Fed is expected to make two additional cuts by the end of 2024, followed by four more rate cuts in 2025. We can expect to see mortgage rates trend down this autumn and even more next year.

Dig deeper: How the Federal Reserve rate decision affects mortgage rates

A mortgage-backed security is an investment vehicle that pays investors a portion of the principal and interest payments made by the mortgage holders in a collection of home loans. A government or private entity purchases home loans from mortgage originators. Then, that entity issues securities, or the rights to the principal and interest payments, to investors. Most mortgage-backed securities are issued by Fannie Mae and Freddie Mac, which are two U.S. government-sponsored enterprises (GSEs).

“Investors who buy MBS are the ones who ‘set’ rates by bidding on the bonds issued by Fannie [Mae], Freddie [Mac], or Wall Street investment funds,” said mortgage adviser Casey Fleming. “They know what yield they want for this type of investment, so they take the anticipated income stream and discount it by that rate to a present value. That's what they bid for a specific issue of bonds. The seller obviously takes the highest bid, so the cost of using that money (the interest rate) is now set.”

“When demand for MBS rises, their yields decrease, which in turn lowers mortgage rates. Conversely, a decrease in MBS demand causes yields to increase, leading to higher mortgage rates,” Thomas added.

The 10-year Treasury measures long-term interest rates. You can buy 10-year Treasury notes, bonds, and bills, which are all types of safe investments, just for different term lengths.

But the 10-year Treasury yield is also a good indicator of how mortgage rates are moving. If the 10-year Treasury yield goes down, mortgage interest rates tend to decrease too.

At its core, inflation results in increased prices and decreased purchasing power. Lenders feel the financial pinch just like individual consumers do, so they increase interest rates to offset the loss. Conversely, lenders will usually keep interest rates low when inflation is low because the institution’s money stretches further.

“Inflation, inflation, and inflation are all that really matter to long-term rates,” said Fleming. “Fed movement often correlates with inflation since they raise short-term rates to slow the economy to cool inflation.

“[However], it all comes down to what institutional investors think inflation will be for the duration of the time that their money will be out. They have to earn more than inflation, or else they are losing money. So, in a real sense, future inflation sets mortgage interest rates.”

Learn more: Which is more important, a low interest rate or house price?

It makes sense that the economy at large plays a role in determining mortgage rates. Inflation, employment — these are all individual parts of the economy that affect rates.

“The economy affects mortgage rates a lot. When more people have jobs and make more money, they feel better about buying homes, which can push up mortgage rates because more people want loans. But in a weak economy where few people have jobs and wages stay the same, fewer people want mortgages, so rates can go down,” said Thomas.

Basically, a weak economy generally leads to lower rates (think of the height of the COVID-19 pandemic, when rates fell to all-time lows), and a strong economy results in higher rates.

Government assistance can also impact mortgage rates. “Programs that help people buy homes, like tax breaks or affordable housing loan programs, can make more people want mortgages, which might raise rates,” Thomas said.

She also explained that new government plans and laws might help keep rates low if they provide money for home loans. On the other hand, they can increase mortgage rates if they encourage more people to buy houses and drive up demand.

The American economy and news cycle aren’t the only things that impact mortgage rates — rates can be affected by global events too.

“If other countries have problems with their economies, investors might put money into safe things like the U.S. Treasury bonds, which can lower mortgage rates here,” said Thomas. “But when global markets are steady, rates might go up because more investors are interested in bonds and mortgages.” She points out that elections or tensions between other nations might make investors choose to put their money in low-risk assets, like U.S. bonds, which can lead to lower rates.

Fleming once again pointed to the power of inflation. “The pandemic created huge supply chain issues, which created a shortage of goods. Then, government stimulus programs threw billions of dollars at Americans. Fewer goods to purchase and more money to buy them created low supply and high demand, and so an inflationary spiral, pushing up interest rates,” he said.

External forces converge to set mortgage baseline rates. However, your loan details, financial standing, and new property information refine that baseline, resulting in a custom borrowing cost. These are factors you do have some control over. We’ll examine those elements more closely.

Your mortgage itself has a significant impact on your interest rate. Here’s how each characteristic contributes to it:

  • Term length: A shorter-term mortgage usually has a lower interest rate — for example, you’ll get a lower rate with a 15-year term than a 30-year one.

  • Type of mortgage: An FHA loan generally has a lower interest rate than a conventional mortgage. However, it often comes with higher mortgage insurance costs that are difficult to cancel.

  • Loan amount: A larger loan might have a higher interest rate because the lender takes on greater risk.

  • Down payment: A higher down payment will likely result in a lower interest rate because the lender assumes less risk.

  • Fixed vs. adjustable rate: A fixed-rate mortgage tends to have a higher rate than an adjustable-rate mortgage, but Fleming indicated the difference between the two is currently slim.

  • Closing costs: Rolling your closing costs into your mortgage (rather than paying them in a lump sum on closing day) may result in a higher interest rate because you’re borrowing more money and putting less financial skin in the game up front.

Thomas also pointed out that you can buy mortgage discount points to lower your rate. Typically, a discount point costs 1% of your loan and lowers your mortgage rate by 0.25%. So, if you have a $300,000 mortgage with a 7% rate and buy one discount point, you’d pay an extra $3,000 at closing and have a 6.75% rate.

Dig deeper: 5 strategies to get the lowest mortgage rates

Thomas noted that a higher credit score can help you get a lower interest rate “... because it shows lenders you've managed debt responsibly in the past.” In addition, a lower debt-to-income ratio (DTI) — a measure of how much you earn in relation to how much you owe monthly, expressed as a percentage — may yield a lower interest rate because less debt suggests you’re able to afford mortgage payments and are a lower-risk borrower.

Read more: The credit score needed to buy a house

“The type of property you're buying also matters,” said Thomas. “Single-family homes usually have lower rates than condominiums, and primary residences generally get lower rates compared to second homes and investment properties.”

Plus, your property’s location can impact your interest rate. Your lender may offer different loan rates depending on which state you live in.

Learn more: 12 popular types of houses

Lenders start with the baseline, consider the individual borrower’s situation, and then may further adjust the rate based on the financial institution’s circumstances. For instance, “... larger banks typically face higher operational costs, while smaller lenders may have lower expenses, allowing them to offer lower rates to borrowers. [In addition], during periods of high demand, banks may raise rates to handle [the] increased workload efficiently,” said Thomas.

“The rates offered to borrowers can vary significantly between lenders due to variations in the profit margins they incorporate into their rates, creating interest rate differences by several percentage points,” Thomas continued. “Mortgage brokers often shop around among lenders to secure competitive rates through wholesale lending.”

No matter what’s happening in the housing market, there are steps you can take to get the best possible mortgage interest rate. “Focus on improving your credit score by reducing debts and paying bills on time. Saving for a larger down payment can also enhance your eligibility,” said Thomas.

Fleming said the best thing you can do is shop around. But he points out that you should get quotes from multiple mortgage lenders on the same day if possible because rates change daily.

Mortgage rates aren’t the only costs that matter, though. You should also look at mortgage lenders’ fees when comparing companies.

“Consider the overall cost associated with the advertised interest rate, including origination fees, application fees, and discount points,” said Thomas. “For example, a lower advertised rate may not be the best option if the origination fees are higher, especially if the borrower plans to stay in the property for only a few years. Conversely, if the borrower intends to make this a long-term residence, the lower rate and higher fees may better serve them.”

Currently, 30-year mortgage rates and refinance rates are roughly the same. However, there will be some variation from lender to lender, and refinance rates are sometimes slightly higher.

Locking in your mortgage interest rate guarantees it won’t change before you close on your house. “On purchase loans these days, a borrower should lock the rate as soon as they go into escrow because the market is so volatile, and if rates jump, they may no longer qualify. On refinance loans, a borrower can be a bit more strategic and try to play the market or wait for a short lock,” said Fleming.

You can change your mortgage rate during the home-buying process by paying for mortgage discount points. For every 1% of your loan (one point) you pay up-front, your lender will reduce your interest rate by a certain amount. After you close on your original home loan, you may be able to lower your interest rate by refinancing the debt.

This article was edited by Laura Grace Tarpley