Factors That Affect Mortgage Rates
Ever wondered how they manage to squeeze so much of your hard earned money out in interest? Here's a list of some factors, some surprising, which will affect your interest rate.
First and most loved is the "prime rate". This is based on the US federal reserve rate (or the central bank rate in other countries). For most lenders, their prime rate is the central bank rate, plus a couple of percentage points or so. However, you may have noticed that the bank prime rate varies in how much more it is than the Federal Reserve rate. That's because...
Our second factor is bond yields. Now what would bonds have to do with the amount of money you pay in interest? Here's the readers' digest condensed version: bond "yields" are the interest rate an investor gets paid on a bond. It's affected by the economic climate: the more risk perceived in the market, the higher the yield on the bonds. It's the general sense whether bond prices will go down, and interest rates up. Banks take a look at those bond interest rates (or yields) and then tack on a premium for the risk and services associated with a mortgage. (Basically, it costs more to service YOU, than to invest their money in bonds.) If interest rates on bonds are going down, your mortgage costs will likely be going down too. If bond yields are going up, your mortgage will be going in that direction.
Our third factor is inflation. If the economy grows very quickly, it could lead to the Federal Reserve raising rates to hold inflation in check. Which means that prime at the lending banks will go up. Which means -- you guessed it -- your rate goes up.
Our fourth factor is supply and demand. Supply and demand? Yep. There is a supply of money and a certain demand on it. When the economy is going well, there can often be a high demand for money (in the form of mortgages) and lenders can then get a bit more interest out of you. There are other reasons for increased demand though -- like a surge in refinancings or an internal need for the lender to address the theirl balance of loans and risk. (This is why we are always harping on this site about the need to shop around! You really can get substantially different interest rates from different lenders.)
Which brings me to a factor that I like alot, because it's in the consumer's favor: Lender competition. Organizations out there are competing for your borrowing needs. Especially if you have a good credit rating, you should be taking advantage of that. After all, you are going to make some nice lending institution a lot of money for their efforts. For that privilege, they should be "courting" you.
Here's a factor I bet you haven't thought about: What if the lender has a lot of money laying around in deposits? Well, they want to make money on those deposits! One of the best ways to do that (and retain control of the money) is for that lender to lend it out. This may encourage certain lending organizations to offer really good interest rates in order to get more borrowers. (It's another supply and demand related factor, but on a much more lender-specific basis rather than overall market basis.) Some small mortgage companies that are building their business will offer rates as much as a full percentage point lower than other lenders.
Last (but not least) in our list is your credit rating. If you are a better bet, you get a better rate. If you are a higher risk, you get a higher rate. However, as this list of factors shows, you can still shop around and find yourself the best possible rate.
Happy Mortgage Hunting!