Your Questions About Mortgage Rates

Lizzie asks…

How are mortgage interest rates determined?

What I mean by that is I assume there is a formula which banks use to figure out what mortgage rates to offer a customer based on prime rates, customers credit history, size of mortgage, etc…

Does anyone know how this process works and the specific formula/methodology used?

thanks in advance!

admin answers:

Rates are determined by investors in the secondary market.

Most loans are originated for sale to Fannie and Freddie so they rates that anyone can offer depends on what Fannie and Freddie can afford to offer on a program (e.g. 30 year, 15 year, etc.) which in turn is driven by what their investors require for a return/yield on their money.

The link below tells you what Fannies investors are requiring roughly.


Then the Fannie/Freddie have to add a spread to that in order to make any money. The link below would represent a “par” rate based on delivery dates for various Freddie programs:

Then, a lender either has to charge fees or offer a slightly higher rate in order to make any money.

Today, we were offering 6.875% with closing costs of $350 in our market.

Of course this conversation does not address the delievery fees required by the agency programs based on credit scores, loan to value, transaction type and occupancy. These delivery fees will add to the closing costs or increase the rate or both if the delivery fees cannot be covered by increasing the rate.

Home equity and portfolio programs are priced by individual banks and there is no single methodology or formula. If they are lending there own money, they can price there programs how ever they like.

There is a similar secondary market for government programs, Ginniemae, which operates a lot the same as the secondary market created by Fannie and Freddie. The big difference is that these are owner occupied programs and there are not as many delivery fees as with the Fannie and Freddie programs.

I hope I have helped to illuminate the subject without over complicating things.

Mandy asks…

Can someone explain in laymen’s terms how mortgage rates are set by the 10 year treasury yield?

I know that investment companies buy 10 year treasuries from the US government and that as stocks become less attractive, these investment companies have more demand for the treasuries, thus the government can lower the yield they need to pay (basic supply and demand). What I don’t get is how this treasuries relates to mortgage rates. I can’t quite make the connection. Thanks in advance.

admin answers:

They are used because they have such a long time line. 10 year and 30 year bonds. At one time the 30 year bond and mortgage were paired. Then 30 year bonds were discontinued. So everyone used the 10 year.

US Treasury bonds are the safest investment in the world. Everything else is more risky. So a home mortgage might be 4.5% when the 10 year bond is 3%. The difference is the “risk premium”. An investor is positive he will get his money back in 10 years with the bond. He is less certain with the mortgage. So he demands more interest for more risk.

Ruth asks…

Question about the Treasury Dept’s efforts to freeze adjustable mortgage rates?

I do not understand why the Treasury Department has to step in to negotiate the freezing of mortgages rates.

Why cant the banks/mortgage companies use their own discretion by doing it themselves?

You would think it would make good business sense to freeze the rate and having a mortgagee continuing paying the mortgage than having the loan forclosed altogether…

An explanation to why these companies are not already doing this would be helpful. Thanks.

admin answers:

Actually, none of the above are correct. The problem is a problem of timing, duty and risk.

Imagine that there is a real estate market in equilibrium, but facing a block of foreclosures in addition to normal supply and demand relationships. The foreclosures will add supply but will not alter demand for purchased homes. The foreclosed may look for rental housing or move, but they will not look to purchase since they will not be eligible.

Since this is a serial process dependent upon liquidity available and the public does not know the magnitude nor timing of the foreclosures, so prices will fall month after month. Therefore there is an incentive to be the first to foreclose since you will realize higher prices and lower losses on your loans.

This has a potential to create a rush to foreclose causing everyone to lose who is holding debt, raising homelessness beyond the ability of communities to manage, and triggering losses for the FDIC and PBGC. Further, it is bad for elected officials in an election year. Also, ordinary homeowners could find their homes non-marketable or marketable at very low prices. This will cause people to be inflexible in looking for employment making the entire economy less efficient, making profits lower, making wages lower, putting more strain on the credit markets.

Banks can use discretion, but each one individually must foreclose as quickly as possible unless an agreement can limit how much any one of them forecloses. A run to foreclose would be much like a run on the bank, everyone gets burned and no one gets what they want. If they can agree on a mechanism, they can go to shareholders with a good citizen stance, be able to fight the internal politics and if it is enforceable protect themselves from one another. Cheating is in everyone’s interest so protection from cheating is very important.

Rate freezes only make sense if the Treasury can promise low rates, which would be the same as promising high inflation. This will cause the mortgages to be worth less in a real sense, but profitable in the nominal sense. Bondholders will get hurt, potentially alot, but the banks will be fine, the homeowners will be hurt less than otherwise and the politicians will get re-elected.

Helen asks…

Is today’s stock market rally going to influence the mortgage interest rates tomorrow?

I’m debating to lock in my mortgage today with not so great rates that closed on Friday. Today had a huge stock market rally, do you think the mortgage rates will drop tomorrow?
What I’m debating is should I lock in rates today or wait until tomorrow because of this rally? I know morgage rates are tied to bonds.

admin answers:

No. Mortgage interest rates are not tied or related to how the stock market does on any one specific day. Mortgage interest rates are set using other base interest rates such as the LIBOR rate, etc.

Carol asks…

Does my mortgage rate go down if interest rates are cut?

Sorry to ask the shocking stupid question! I am coming to the end of my mortgage term ( end of September) and am wandering if the mortgage rates will go down (currently for at 6.99%). Do you think it will go down by this time? I am in the UK.

admin answers:

If your rate was artificially low, it will go up even if rates in general go down. Otherwise it will follow the market. /

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