Types & Terms | Home Loan Mortgage

How Mortgage Rates Are Determined

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Mortgage Mike
Mortgage Mike
June 17, 2020 | 4 Minute Read

For many individuals, taking out a loan is the only way to afford a property and an interest rate is applied to this loan which acts as a cost against borrowing the money. However, this interest rate will change from one loan to the next and certain factors determine the percentage of a mortgage interest rate.


But how are mortgage rates calculated exactly?


Let’s take a look at the role of interest rates and the most common factors which determine the cost of borrowing money to pay for a property. But before we take a closer look at factors that dictate mortgage rates, it’s important to be clear on the basic role of an interest rate.


The Role and Intricacies of Mortgage Rates


It should be known that this “cost” is also insurance for the lender against the money being borrowed. In short, a mortgage interest rate is the price of the money that you might wish to borrow against the security of a property. However, this interest is a form of insurance for the lender, this also means that interest rates are non-refundable for the person borrowing the money.


When it comes to most home loans, this rate is paid monthly but quoted by the lender as an annual rate. For instance, an interest rate of 3% on a $200,000 mortgage will require the borrower to pay mortgage interest of $500 per month ($6,000 per year). But interest is just one of several costs as fees are also needed to cover the title insurance and “points” in the form of a percentage of the loan. What’s more, a mortgage insurance premium is required and included as part of mortgage rates.


You will also see an APR alongside a mortgage interest rate and this is an adjusted rate that includes the other charges cited above. It’s reasonably accurate but not exact because the APR assumes these charges are spread out over the remaining lifespan of the mortgage. Also, mortgage rates are either adjustable or fixed. Adjustable rate mortgages (ARMs) have a fixed period of between six and ten years but the rate can be adjusted over time. Meanwhile, fixed-rate mortgages have an interest rate which stays the same for the duration of the loan.


As for why so many fees and costs are needed, lending institutions are taking on risk when they loan money and this risk extends to both the borrower and wider economy. That is to say, you might receive a high or lower rate of interest due to your finances or circumstances but the economy as a whole is also a risk to the institution.


3 Main Factors that Dictate Mortgage Rates


Although a complex system of factors will affect mortgage rates, three factors will essentially determine how much investors might be willing to pay for shares in a mortgage-backed security – inflation, the Federal Reserve and the price of U.S Securities:


Rate of Inflation – Inflation is a phenomenon where prices rise across the board in the economy as a whole. Consistent inflation is a sign of a healthy economy. However, this also poses a problem for lenders as the money being borrowed today will be worth less by the time it’s being paid back. For this reason, investors will only consider high mortgage rates to make up for any loss related to inflation.


Federal Reserve – The Federal Reserve can make rate adjustments which indirectly impact mortgage rates. As you know, the federal funds rate is the rate which banks will use when providing loans to other banks and a rise or drop in federal interest rates will lower or higher the supply of money available.


Price of U.S. Treasuries – The price of U.S treasuries is also highly influential because other investment opportunities can distract investors from mortgage backed securities. In other words, investors compare these tranches of mortgages to bonds, funds and traditional stocks.


About Calculating the Rate of Mortgage Interest


A lending institution will use a specific formula to create a suitable payment schedule which accounts for paying back both the principal and interest each month. The length of a loan will also dictate how much is needed to be paid back each month. For “fully amortizing payments”, the loan is paid back in full by the end of a set term. With a fixed rate mortgage, each payment is for an equal amount but the payment will change according to the interest rate with an adjustable rate loan. When a mortgage is stretched out to thirty years, the payments are usually lower but the longer this period, the higher the overall cost.

Final Thoughts


For many families and first time buyers, taking out a loan is the only option when it comes to buying a property. However, this is also a realistic way to achieve safety security without risking your finances. Finally, the intricacies of the secondary mortgage market can be somewhat confusing but understanding mortgage rates is often the key to finding the best possible mortgage provider for your dream home. To learn more about mortgage rates, call City Creek Mortgage and speak to one of our salary-based loan officers.