Estimated reading time: 8 minutes
Every month, the Federal Reserve’s decisions on whether to raise, lower, or hold benchmark rates spark widespread discussions across financial markets and news outlets. While these decisions influence the broader market, they don’t directly determine the interest rate your mortgage lender will offer. Instead, mortgage interest rates are influenced by market conditions, investor demand, and borrower-specific factors like your credit profile, loan type, occupancy, loan-to-value ratio, and overall risk.
Instead of getting caught up in the news of every Fed update, it’s more helpful to understand what the Fed actually controls and the other key factors that directly impact your interest rate.
Your mortgage interest rate is the price you pay to borrow money from your lender and is expressed as a percentage. It is charged on top of the principal loan amount by your lender and is paid as part of your monthly mortgage payments.
This is different from your APR, which includes additional costs associated with your loan.
The Federal Reserve, also known as the Fed, serves as the United States’ central bank. The Fed is responsible for managing monetary policy to promote stable prices, maximum employment, and moderate long-term interest rates.
No, the Federal Reserve does not directly set mortgage interest rates. The Federal Open Market Committee (FOMC) makes decisions on the federal funds rate. While it doesn’t directly set mortgage rates, its policies influence the broader financial markets that mortgage rates depend on. The federal funds rate dictates how much money banks pay each other in interest to borrow funds, which can then influence the borrowing costs for households, businesses, and broader financial conditions.
Mortgage interest rates may sometimes move in the same direction as the federal funds rate because they’re affected by some of the same factors, such as the labor market and how high inflation is.
Inflation represents the sustained increase in prices for goods and services over time. It can reduce purchasing power and increase the cost of living, meaning each dollar buys fewer goods and services than before.
Inflation is one factor that can influence interest rates, but mortgage rates may also change based on bond market activity, economic, expectations, and investor demand.
Mortgage interest rates are also influenced by supply and demand in financial markets. When investor demand for mortgage-backed securities is strong, lenders can offer lower interest rates. When demand weakens, lenders may raise rates to attract more investors.
For example, in 2020, mortgage rates fell during a period of intense economic uncertainty, Fed policy changes, and strong demand for fixed-income assets.
Mortgage lenders originate loans, bundle them together, and then sell them to investors on the secondary market. Investors who purchase these loan bundles receive the right to collect the money owed. The value of mortgages on the secondary market depends on their risk and potential return. Higher-risk loans offer higher returns than lower-risk loans, which is one of the reasons why people with lower credit scores pay higher interest rates.
Whereas the primary mortgage market has borrowers receiving mortgages from lenders, the secondary market doesn’t involve borrowers at all. If your mortgage is sold on the secondary market, your loan terms generally do not change. However, your loan servicing may or may not change. If it does, you’ll receive notice with instructions about where to send payments.
While you can’t control inflation, supply and demand, or the secondary mortgage market, there are personal factors that do affect your mortgage interest rate. By focusing on these things, you’ll feel more in control and confident as you move through the mortgage process.
Your credit score is a number that represents your overall creditworthiness, or the level of financial risk associated with lending money to you and the likelihood that you’ll pay back your debt over time. Credit scores are generally influenced by factors like payment history, amounts owed, length of credit history, new credit, and credit mix; although scoring models may weigh these factors differently.
When you apply for a loan, like a mortgage, your lender is looking for a high credit score. The higher your score, the more trusting a lender will be that your finances can handle the additional debt of monthly mortgage payments. To reward this trust, your lender may give you a lower interest rate than if you had a lower score.
Your debt-to-income ratio (DTI) is used by lenders to determine your ability to pay back your monthly mortgage payments. They will look at how much you owe (your debt) and compare it to how much money you earn (your income).
Unlike your credit score, a lower DTI ratio is better than a high one. A high ratio may indicate that your income can’t support the debt that you currently hold, which could lead to a higher interest rate. This is to compensate for the additional risk a lender takes on by issuing you a loan.
In many cases, lenders look for a debt-to-income ratio around 43% or lower, though some loan programs may allow for higher ratios, depending on your financial profile.
The ideal down payment percentage is dependent on the loan program you choose. In general, a larger down payment means a lender is taking on less risk when they issue you a loan because it lowers the overall cost to borrow.
Your down payment also affects your loan-to-value ratio, which is another metric mortgage lenders use to evaluate the risk of issuing you a loan. This ratio compares the amount of money you’re borrowing to the value of the property being purchased. The higher your LTV, the more your lender may lose if you miss making your monthly mortgage payments. To offset this risk, your lender may charge you more in interest.
Not all mortgages are the same. Each loan program has its own eligibility requirements, which also leads to different mortgage rates. As an example, FHA loans may sometimes have lower note rates than some conventional options, but the total cost of the loan can vary because of mortgage insurance and other factors that also affect affordability. Jumbo loans may have higher or more variable rates, depending on market conditions and borrower qualifications.
While the Federal Reserve meetings don’t directly set your interest rate, its policies play an important role in shaping overall borrowing costs. While you can’t control market conditions, strengthening your credit score, managing debt, and exploring loan options may help improve the terms available to you.
When it comes to your finances, working with a lender you can trust to answer questions and cut through the noise is important. That’s why our Loan Originators work so personally with their borrowers every step of the way. Ready to connect with a mortgage professional who cares? Reach out to us to get started.
Homestead Funding offers exceptional customer service and a convenient mortgage process. Whatever your financing needs, our goal is to exceed your expectations.
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