How are Mortgage Rates Determined?

What’s life without a Selling Residential Real Estate little risk? To try to be fiscally prudent in the long term, you may decide it’s best to invest in a house. To get the job you want, you may need formal education. That may sound cliché, but in today’s credit-dependent culture, it can be difficult or even unwise to go through life without taking some sort of gamble with your finances. To make a living, you’ll need a job. To get to work, you may need a car.

Economists believe this helped lead to the 2008 financial crisis. For lenders, inflation poses an inherent problem — it means that the money people borrow now will be worth less when they come to pay it back. Ultimately, several factors, including the rate of inflation, the price of U.S. Let’s start with inflation, which is the phenomenon where the prices of common goods and services rise across the board. That’s because all these things and more affect how much investors are willing to pay to invest in the mortgage-backed securities (MBSs) we discussed on the previous page. Consistent and moderate inflation is actually a sign of a healthy economy, and should ideally result in a proportional rise in wages for workers as well. Federal Reserve, affect mortgage rates.

If economists predict a rise in inflation, investors will insist on higher mortgage rates to make up for this loss. You might assume a 30-year fixed mortgage would compare to a 30-year treasury. But in reality, borrowers in 30-year fixed mortgages are likely to refinance or move after only 10 years. Like with bonds and other financial instruments, investors often compare MBSs against U.S. Because investors have many choices of where to invest their money, competition among other investments also determines mortgage rates.

But that price is based on the price at which the tranches of mortgage-backed securities are sold. So, if investors help determine mortgage rates by deciding how much they are willing to pay to invest in mortgage-backed securities, we could ask what goes into such decisions. And, because the price of tranches depends on how much investors are willing to pay for them, investors largely determine mortgage rates. The popularity of mortgage-backed securities among investors encouraged lenders to lower their standards and offer more sub-prime mortgages (mortgages to high-risk borrowers with low credit ratings). And that’s exactly what we’ll explore next.