Whenever someone asks me what I do for a living, and I tell them I am a Mortgage Originator (Loan Officer) the first question I usually get is “What is your or what are Mortgage Rates doing?” or something to that effect. Well to answer that properly takes more time than most people would have in a brief conversation.
Mortgage rates change daily and can sometimes change multiple times per day. In this article, “mortgage rates” I’ll refer to the combination of upfront cost and actual interest rate. For example, if we talk about “higher rates,” it could either mean that the interest rate is higher, or simply that the upfront cost or “points” are higher for the same interest rate.
These frequent changes are not arbitrary in any way. Instead, they are the result of multiple factors with varying levels of importance and interdependence. Mortgages exist because investors want to earn interest by offering loans. Because of this, mortgage rates end up being directly driven by all the various market forces and operational considerations that dictate what those investors can/should/must charge.
Factors relating to market forces
Much like mortgage borrowers need money to buy a home, the US government needs money to finance Federal spending. Political commentary aside, this creates a massive market for government debt, which in turn serves as the plainest, most risk-free benchmark for many other types of debt. Collectively, this is known as “the bond market.”
There are many other types of bonds with varying levels of risk and different features. They all exist because investors need or want to lend money and various entities need or wants to borrow money and Mortgage borrowers are one such entity. When lenders have enough of the same type of loan from mortgage borrowers with similar circumstances, those loans can be grouped together to form a bond that can then be sold to other investors. This is called “Securitization”. Once the mortgage lender sells those loans to other investors, they now have the cash flow to go make new loans - assuming there are other investors who are interested in buying more loans.
Thus, a market for these mortgage-backed-securities (MBS) is born. It’s quite a bit more complex in practice, but generally speaking, it’s simply a market for groups of loans. These trade on the open market and tend to follow the broader movements of more mainstream bonds like US Treasuries. In short, all the factors that can affect interest rates in the bond market can also affect the price that investors are willing to pay for these groups of mortgages. Those prices have a more direct influence on the rates that mortgage lenders can offer than anything else!
Bottom line: loans become mortgage-backed-securities which trade on the open market, and the prices of mortgage-backed-securities dictate the rates that lenders can offer to new mortgage borrowers.
Factors relating to operational considerations
Knowing the price that investors are willing to pay for a group of similar mortgages gives lenders a baseline for the costs they must charge borrowers. The lender’s operational considerations will account for the rest. These considerations are all directly or indirectly related to how much profit the lender wants to make or how much business they can do.
For instance, we tend to think of banks as always being available to make loans to borrowers who fit the right criteria, but that isn’t always the case. Many mortgage lenders have a certain amount of cash flow that they’d ideally like to use over a certain time frame. If a lender isn’t on pace to lend as much as they’d like, they might lower rates to entice more business. Conversely, if a lender is on pace to lend out more money than it has, it could raise rates to deter business.
Apart from the availability of funding, lenders must also consider the availability of personnel. It takes human beings to make loans happen, and at a certain point, a lender will be at capacity. It can then either hire more staff or simply raise rates to throttle the amount of incoming business.
These are two of the most basic operational considerations for lenders that complement the actual market-driven prices of mortgages. This can be thought of as any sort of business that sells a product made from raw materials. A car company, for example, is greatly affected by the cost of steel and aluminum, but the cost that buyers end up paying is also greatly affected by how that car company does business. How many factories do they have? How well-trained are their employees? How efficient are they?
In the mortgage world, mortgage-backed-securities would be like the steel and aluminum while individual lenders would be like auto manufacturers, each trying to build/sell cars as efficiently and as profitably as possible. Even with the Mortgage process becoming more automated thanks to AI and technology, this is still a consideration for Lenders of all size and type.
Borrower Characteristics
Mortgage Rates can be different for two different Borrowers buying an identical house for an identical price based on certain characteristics of their financial situation. The factors that affect Mortgage Rates the most between individual borrowers are Credit Score, Loan to Value (LTV), Transaction Type, Occupancy, Property Type and Loan Type. Borrowers with a higher credit score will generally get a lower Mortgage Interest Rate than those with a lower score. For Conventional Financing, the Credit Score brackets are in 20 point increments starting at 620 and going up to 740. The LTV or percentage of the Purchase Price a Borrower(s) will finance also is a major factor. The LTV brackets start at 97%, then 95% and go down top 60% in 5% increments. These are the too most influential factors for Borrowers Mortgage Rates on any given day. The Transaction types are Purchase, Rate-Term or Limited Cash Out Refinance and Cash-Out Refinance. Occupancy factors are Owner – Occupied or Non-Owner Occupied which encompasses Second Homes and Investment Property. Property Type includes Single Family Detached or Attached, Condominiums, and Multi-Unit Property. Finally, Loan Type refers to Conventional Financing, FHA, VA or USDA (Rural Housing) Loans. All these factors can go into the Interest Rate that a Borrower may be offered from a Lender when making Application for a Mortgage Loan.
Bringing it all together
The lender-specific considerations certainly change and certainly account for a portion of any given mortgage rate offering. Quite simply, this is why different lenders offer loans at different rates even though they’re all working with the same raw materials.
But it’s those raw materials—those mortgage-backed-securities—that move throughout the day and do most to affect the moment-to-moment changes in lenders’ rate sheets. If something in the world is happening to cause investor demand to increase in bond markets, MBS tend to benefit as well. When MBS prices rise, investors are willing to pay more for those bundles of loans, meaning that lenders may be able to offer lower rates. Conversely, if investors are seeking riskier investments for whatever reason, MBS prices could fall, meaning investors aren’t paying as much for mortgages, thus forcing lenders to raise rates.
As the world’s financial systems have become linked more closely together through Globalization, what happens in Europe and Asia also has an effect in the United States. Looking at our current situation for an example, as Inflation in Europe rises and yields on European bonds moves higher, the yields on bonds in the US will also move higher because investors buying US bonds will command a higher yield to buy or they will just buy in Europe where those yields are higher.
So next time you meet a Mortgage Originator/Loan Officer, and your instinct is to ask how or what are Mortgage Rates doing, you might want to make sure you have a few minutes and if there is a bar nearby as you may need a drink after the explanation.
Eric Sayer | Loan Officer
Mobile (919) 601-3825
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