Mortgage Interest Rates 101

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What is a mortgage interest rate?

A mortgage interest rate is the percentage of the loan amount a lender charges you to borrow money to buy a home. It's the cost of borrowing.

Here's how it works in simple terms:

• When you get a mortgage, you borrow a large sum from a bank or lender.

• The interest rate is how much extra you pay the lender each year as a fee for the loan, expressed as a percentage.

• For example, if you borrow $200,000 with a 5% interest rate, you'd pay about $10,000 in interest for the first year (not counting principal payments and assuming a simple calculation).

There are two main types of mortgage interest rates:

1. Fixed-rate mortgage: The interest rate stays the same for the life of the loan (like 15 or 30 years).

2. Adjustable-rate mortgage (ARM): The interest rate can change after a specific period, depending on market conditions.

Who sets mortgage interest rates?

Technically, lenders (like banks, credit unions, or mortgage companies) set mortgage interest rates. However, these rates are heavily influenced by larger economic forces.

What affects the rates they offer?

1. Federal Reserve (the Fed):

   • The Fed doesn’t directly set mortgage rates.

   • However, it controls the federal funds rate (the rate banks charge each other for overnight loans), which influences short-term interest rates and the overall cost of borrowing in the economy.

   • When the Fed raises or lowers its rate, mortgage rates tend to follow the same direction, although not instantly.

2. Bond Market (especially the 10-year Treasury yield):

   • Mortgage rates often move in line with the 10-year Treasury yield.

   • Investors consider mortgage-backed securities (MBS) similar to government bonds, so when Treasury yields go up, mortgage rates often rise too, and vice versa.

3. Inflation:

   • Higher inflation equals higher mortgage rates. Lenders need to ensure that the interest they earn keeps up with the decreasing value of money.

4. Lender’s costs & profit margins:

   • Lenders add a markup to cover overhead, risk, and profit.

5. Your personal factors:

   Your mortgage rate also depends on things like:

   • Your credit score

   • Down payment size

   • Loan type (30-year fixed, 15-year, ARM, etc.)

   • Loan amount and home location