If you’re trying to buy a house, you need to understand all the aspects of obtaining a mortgage rate and the various factors that will influence that number.
If you go into your house hunt with no clear idea of how mortgage rates work, you’ll face a more complex process and potentially walk away without the deal you were seeking.
While a number of factors determine mortgage rates, the average person usually can’t comprehend the complex calculations involved or the fact that rates are typically set by a number of economic indicators out of their control.
What most buyers do know is that low mortgage rates are great for the housing market and typically show the best times to buy.
What Factors Determine Mortgage Rates?
If you’re looking for a specific formula on how mortgage rates are determined, forget it. Just know there are things you can and can’t control when it comes to the rate you’re offered.
According to Nerd Wallet, things like your credit score, your down payment, and your loan-to-value ratio are all rate factors you can have a ‘say’ in.
“Right now, money’s really cheap, but you have to have a good credit score to be able to access it,” – Glenn Kelman, chief executive of the online brokerage Redfin
For one, it’s no secret that the lowest mortgage rates go to borrowers with excellent credit. If you’re one of these borrowers holding a credit score of 740 or higher, you’ll likely have a choice of loan products at your fingertips and fewer worries about the process going forward.
NOTE: I think the content in this section should be a graphic/image on the factors that determine mortgage rates
FACTORS THAT DETERMINE MORTGAGE RATES
(Left side) What you can control | (Right side) What you can’t control
Your credit score | Inflation
Down Payment | Unemployment
Loan to Value ratio | Economic growth
*Remember: While your financial health can help determine your interest rate, larger economic factors affect the rate that you’ll be offered.
Now consider if you’re trying to buy a house for $200,000, put $20,000 down and get a $180,000 mortgage, you’re borrowing 90% of the home’s value, so your loan-to-value (LTV) ratio is 90%. When it’s that high, it’s perceived to put your lender at greater risk and so your mortgage rate will be higher as well. As you’ll notice, your ability to save up for a down payment toward your house can skew both numbers. The lower your loan-to-value ratio, the better your rate will probably be.
The things you can’t change are the economic forces at play, including inflation, unemployment, and economic growth. A lot of people keep an eye on the Federal Reserve (which determines what banks pay to borrow), believing cuts to interest rates should encourage mortgage lenders to offer mortgage lower rates. But as many reputable publications are quick to point out, it doesn’t always work that way.
Why Low Rates Are Good for the Market
1. Low Mortgage Rates Help to Stimulate the Economy
Remember what we said about the Federal Reserve? When it slashes interest rates, it’s a measure taken to help stimulate the economy, effectively making it cheaper for people to borrow money.
The Federal Reserve is, by definition, the central bank of the United States. It doesn’t want potential buyers hesitant to go shopping, or folks looking to refinance to keep putting off their application.
The thing you have to remember is that ‘The Fed’ typically acts when the economy is uncertain and it’s looking to kickstart and/or sustain economic growth. In that sense, interest rates matter for the housing market and the financial sector to keep both on more stable footing.
2. Lower Rates Can Drive Consumer Sentiment
According to the Housing Wire, low mortgage rates drove housing market potential to a two-year high at the beginning of 2020.
At the time, it was a sign that consumer sentiment — an indicator measuring how consumers feel about their own personal finances and the economy — was high.
Potential home buyers want to see a degree of optimism. After all, it gives them their own ‘feel free to spend’ kind of attitude. It also has the opposite effect when attitudes toward spending are getting worse over time. If there are signs many other folks are tightening the belt, so to speak, those homebuyers might decide now is not the right time to buy.
3. Low Mortgage Rates Can Boost Affordability
We’ve all heard the term “buying power” — it’s something you really want to have as you’re talking to lenders and going through the home buying process.
The fact is, low mortgage rates make it easier to afford homes even if property prices increase.
A report published by the National Association of Realtors in Feb. 2020 said an index that measures home affordability for first-time homebuyers rose to 107.3. That was up from 96.3 a year earlier, and the reading over 100 conveyed that household median income was more than enough to buy a median-price starter home. A broader index measuring the overall market also jumped.
These numbers are important because Americans typically have a harder time dealing with a shortage of available properties and prices rising at a faster pace than incomes. Lower mortgage rates can offset these issues, lowering monthly payments and making it easier for homebuyers to purchase a property.
NOTE: I think what might work here is a tip on ‘How Much House Can I Afford?’ Maybe include something like: “Are you thinking about buying a house? Your mortgage rate will be important, and you’ll need to consider your other monthly obligations such as child care, auto loans, credit card debt, and student loans. Mortgage lenders will consider all of these when they factor in your debt load and help you find the best mortgage type for you.”
Do Persistently Low Rates Help?
While lower mortgage rates can help move both home buyers and sellers to act, some say persistently low mortgage rates can be a hindrance to the housing market.
Some experts point to a decades-long decline in the 30-year, fixed mortgage rate as a stimulator of the market. They say it increased affordability and encouraged homeowners to look at their options. But while low rates make it more affordable for buyers to purchase, those same experts say it may discourage existing homeowners from selling. Instead, they want to ride out their own income growth and choose to stay where they are, reducing the number of homes for sale. This is seen as a duality of low mortgage rates.
Is it a bad thing? Not necessarily.
So-called tenure length (or how long a homeowner actually stays in their home) has increased, statistics show. In fact, by December 2019, tenure length reportedly approached 12 years. That’s nearly double what it was a little more than a decade ago, but it hasn’t really hurt the industry and there’s been no huge decline in the market.
The truth is, there are so many factors that go into someone’s decision to sell their home. Beyond that, a lack of available homes for sale has been an issue for several years, but one the housing market has been able to overcome.
What Does the Future Hold for Mortgage Rates?
The consensus is that mortgage rates will remain low — likely below 4 percent — for the next few years. This will likely continue to boost demand, but there are so many other factors to consider.
What will the health of the overall market look like? Supply and demand must be taken into consideration, and seeing activity at a healthy level can help you decide if it truly is the best time to buy or sell.
Note: Maybe a final tip here saying something like ” If you’re been shopping for a mortgage, it may make sense to pull the trigger and lock in a rate you’re comfortable with. Just make sure you’ve really shopped around for the best rate before making a final decision.”
- How Are Mortgage Rates Determined? Nerd Wallet. Accessed at https://www.nerdwallet.com/blog/mortgages/how-are-mortgage-rates-determined/
- How Do Lower Mortgage Rates Affect Your Buying Power? New York Times. Accessed at https://www.nytimes.com/2020/04/02/realestate/how-do-lower-mortgage-rates-affect-your-buying-power.html
- Low mortgate rates drive housing market potential to a two-year high, Housing Wire. Accessed at https://www.housingwire.com/articles/low-mortgage-rates-drive-housing-market-potential-to-2-year-high/
- Consumer Confidence vs. Consumer Sentiment, Investopedia. Accessed at https://www.investopedia.com/ask/answers/09/consumer-confidence-sentiment-difference.asp
- Low mortgage rates offsetting home affordability issues, NAR says; Housing Wire. Accessed at https://www.housingwire.com/articles/low-mortgage-rates-offsetting-home-affordability-issues-nar-says/
- How Low Mortgage Rates Help and Hurt Housing Market Potential, First American Financial Corp. Accessed at https://blog.firstam.com/economics/how-low-mortgage-rates-help-and-hurt-housing-market-potential