What Factors Influence Your Mortgage Rate?

Ever wonder why mortgage rates fluctuate so much?

It’s tempting to envision a Clutch of Bankers ‘behind the curtain’ pulling levers to manipulate rates and opening the floodgates for cash to cascade into their coffers. Or, in oak-paneled boardrooms chortling amongst themselves amid charts of rising profits and issuing directives to harried looking pinstriped assistants. Turning to their fellow Robber Baron or Captain of Industry … “Have a cigar old man!” “Don’t mind if I do!” “Say, did you hear the one about the Priest and the Bartender?” “You there … clear away these oyster shells!”

Not that these scenes don’t play out these days, but normally there are more concrete, if complex, factors involved in the seemingly arbitrary and occasionally dramatic swings. The causes involve millions of consumers, investors and banks around the world.

What follows are a few of the big factors that swing interest rates from day to day. While this list is by no means exhaustive, it provides a good starting point for understanding interest rate volatility in the mortgage market.

Relationship to other investments

Remember that your mortgage doesn’t typically stay with whomever sold you the loan. Mortgages are almost always sold onto the “secondary mortgage market” to buyers such as Fannie Mae and Freddie Mac. Freddie and Fannie don’t hold on to mortgages either, but typically sell them off to investors in the form of mortgage-backed securities.

These bonds are sold in the open market and are in competition with the many investment types competing for investor dollars. If the interest rates are too low on mortgage-backed securities, investors may decide on stocks, bonds, commodities or the many other available options. Therefore the interest rates that banks charge to you the consumer have to be able to compete.

A related influence is the stock market. You may notice while reading the Wall Street Journal over your whisky and soda that when the stock market rises it generally means that interest rates will rise as well.

The reason is that when the mortgage banking industry sells their loans to the marketplace they are in affect raising new money to lend. These bonds then influence their cost of funds. In very simple terms these bonds need to have a high enough interest rate or rate of return to entice an investor away from putting his money on the stock market horse.

The rate of inflation

Inflation is the phenomenon which occurs when prices rise across the board. Moderate and steady inflation is a sign of a healthy economy.

However, inflation poses a problem for lenders. It means that the money that people borrow now will be worth less when they come to repay it in the future. The lender compensates for inflation by raising interest rates a bit.

So if economists predict heavy inflation in the near future, you can expect to see interest rates rise to meet this inflation. Likewise, if inflation is expected to slow, interest rates will likely go down.

The Federal Reserve

Many people have the misconception that the Federal Reserve directly sets mortgage interest rates. Not exactly, but these people, it is rumored, do sit in fancy board rooms from time to time. I hear blackened swordfish has replaced the oyster.

Anyway, the Federal Reserve sets something called the Federal Funds Rate which is used when banks borrow money overnight in order to meet their end of day reserve requirements for ‘cash’. The bank’s cost of funds is then affected either up or down by this interest rate.

The Fed uses this Federal Funds Rate to stimulate or discourage economic growth. By lowering the rate, the Fed helps banks make certain kinds of loans more cheaply. Not just mortgages but for business and consumer lending as well.

By raising the rate, the Fed makes lending more expensive and since fewer people or businesses will be able to afford the higher interest rates then the economy will grow more slowly or even contract.

For the time being, the Fed is holding the Federal Funds Rate at nearly 0% in an effort to encourage bank lending. This action, combined with the still lagging economy, has pushed interest rates to historic lows and produced a fantastic market for consumers looking to among other things purchase or refinance a home.

“Try some of these king crab legs while I tell you about St. Peter and the Three Bankers …”

Neil Funsch has been a mortgage broker for 18 years, the last four in Park Hill. He can be reached at 303-229-2684 or neil.funsch@gmail.com.