Interest rates control your mortgage payment. The higher the rate, the more your mortgage payment costs monthly and over the en9re loan term. If you’ve watched the news lately, you’ve seen how vola9le rates have been over the last year.
So what makes interest rates increase or decrease, and what can you do about it?
Here’s everything you want to know about mortgage rates and what makes them change.
How Mortgage Rates are Determined
You probably wonder who has the magic wand that makes mortgage rates increase or decrease.
It’s the overall economy.
When things are good, rates go up, and when things are bad, rates go down. Here’s the ra9onale.
When the economy is booming, consumers can afford more. They spend more money and are more interested in buying homes. Interest rates increase because demand is up, and homes are selling fast.
When the economy suffers, though, interest rates fall. This is to make buying a home more aErac9ve and to get more homes sold.
A Real Life Example
Let’s look at interest rates over the last couple of years.
During the pandemic, they fell dras9cally because housing sales almost stopped. As a result, rates fell to increase consumers’ ability to buy a home. During the pandemic, rates fell to rates we haven’t seen in decades.
As the economy began recovering and home sales were higher than ever, rates began slowly increasing. Then infla9on hit and kept increasing at uncontrollable rates. This kept interest rates increasing much faster to the point they’re at today, almost double what they were in January this year.
Factors that Affect Interest Rates
So we know the economy’s stability affects mortgage rates, but more intricate factors go into it, including market and personal factors.
Market Factors
Market factors aren’t anything you can control. However, these economic factors drive interest rates for every borrower, no maEer their qualifying factors.
Federal Reserve
You’ve likely heard it many 9mes over the last year – the Fed increased rates. This doesn’t mean the Fed directly increased mortgage rates, though. They don’t control mortgage rates.
Instead, it means the Fed increased short-term rates or the rates banks use to borrow money overnight. If it costs banks more to borrow money, naturally, they’ll increase the rates they charge customers to borrow a mortgage.
InflaCon
We touched on infla9on earlier, but it’s worth men9oning again. Infla9on directly affects mortgage rates. If infla9on rates are high, mortgage rates increase, and vice versa. Rates see the most changes when infla9on increases because lenders must keep up with the pace of infla9on to make lending worth it.
Bond Market
Mortgages eventually get sold as mortgage-backed securi9es or bundles of mortgages. When the demand for mortgage bonds is high, interest rates decrease. But when the demand is low, they increase.
The demand depends on the stock market’s performance. If the market is rocky, the demand for a conserva9ve investment like bonds is high, but when the market does well, the demand for bonds decrease.
The Housing Industry
The housing industry itself plays a major factor in interest rates. When the demand for housing falls, rates fall to increase the demand for homes. This happens when there’s a higher demand for rental proper9es than purchases or when the number of homes being built decreases.
Personal Factors
The above factors aren’t anything you can control. You’re at the mercy of the economy, stock market, and housing demand. However, there are personal factors you can control when qualifying for the lowest available rate when you apply.
No maEer how good interest rates are when you apply for mortgage financing, you won’t get the best rate unless you have these factors.
Good Credit
Your credit doesn’t need to be perfect to get a mortgage, but higher credit scores get beEer interest rates. In addi9on, your credit score tells lenders your risk of default. Conversely, a low credit score means you may have defaulted on loans or had other credit issues in the past and could be a high risk of default.
Low Debt-to-Income RaCo
Your debt-to-income ra9o measures your total monthly debts to your gross monthly income. The lower your DTI is, the lower your risk of default. Ideally, your DTI shouldn’t exceed 43% for the best interest rates.
Lenders measure your DTI by totaling your monthly debts, including:
- Minimum credit card payments
- Student loan payments
- Auto loan payments
- Personal loan payments
- Child support
- Alimony
- Any other monthly debts reported on your credit report
High Down Payment
The more money you invest in the home, the lower your risk of defaul9ng on your mortgage. If you put down more than the minimum amount required, you’ll increase your chances of securing a lower interest rate.
A 20% down payment is ideal for the best rates. It also ensures you won’t pay Private Mortgage Insurance, saving you more money on your mortgage. Even if you can’t make a 20% down payment, any money beyond the minimum requirements will help your chances of ge_ng a low interest rate.
Occupancy
Primary residence mortgages typically have lower mortgage rates than non-owner occupied proper9es. For example, suppose you’re borrowing money to buy a vaca9on home or a property to purchase and rent out. In that case, you’ll get higher interest rates because there’s a higher risk of default on non-owner occupied proper9es.
Final Thoughts
Mortgage rates change o‘en, and you have some control over what you pay in interest on your loan. The key, however, is to look at the big picture. Don’t focus on the percentage, but on how much the loan costs over the term.
To keep your rates down, make your mortgage applica9on as aErac9ve as possible. Save money for a large down payment, improve your credit, and keep your debts as low as possible. The combina9on of good personal and decent economic factors will result in favorable mortgage rates.
