With the ups and downs mortgage rates have had in the past few months, now is a good time to take a look at some factors behind how your mortgage rate is decided.
Thawing the Market
Like most financial products, there is a secondary market for mortgages that brings buyers and sellers together. For your lender to keep business moving they will bundle a collection of mortgages into a security and sell it to an investor, usually a bank or government, to replenish their cash so they can turn around and make more loans. Your mortgage rate is directly tied to the demand for these securities.
In the second half of 2008 investors feared the housing market was headed for another fall and begin to further divest their holdings in mortgage backed securities. Demand fell by 17% through the remainder of 2008 leaving an abundance of supply in the market. This meant prices had to go up. Because lenders were selling less, they had to charge more for what they were still selling to stay in business. That increase in price translates to mortgage rates, which in this case, pushed them up to 7% in October.
With investors pulling away from mortgages, the industry began to freeze back up, and so pressure fell onto the federal government to step in and do something. One move was pledging to buy $500 Billion in these mortgage backed securities starting in January 2009, which they have. By buying the market’s excess supply, prices were able to come down – mortgage rates are now sitting around 5%.
Stuck in the Middle
The other move the federal government made was to lower their target rate for federal funds, which is the interest banks pay to borrow money from the government. Typically a drop in this rate translates to a drop in mortgage rates too, but that didn’t happen this time.
Lenders are currently caught in the middle. On the one side investors, as we saw above, are demanding higher rates because of the perceived risk of buying mortgage backed securities, and on the other side, consumers are demanding lower rates to ease their budgets as the economy recedes.
The problem for lenders is that their business carries the costs of processing and servicing all of these loans (paying staff, sending statements, etc.), so every time rates drop significantly, their operating budgets shrink significantly too. Well, as you’ve probably already concluded, when the federal funds rate lenders just couldn’t pass on the savings this time and instead has to use it to give their business some breathing room to stay afloat.
Down to You
The last factor behind your rate comes down to you. It seems like only yesterday that if you had a credit score of 620+, you got the market price for your rate. Today, however, as we’ve seen above, investors see more and more risk in buying mortgages, so lenders are trying to ease the market fears by increasing their due diligence on each and every loan they plan to sell.
With that, your credit score is still plays a big role, but now you’ll see adjustments to your rate based on how much equity you have or how big your down payment is – the less money in from you, the higher you’re perceived risk will be, and so you’re rate will be higher. Also, if you’re taking cash out or buying an investment property, you can expect to face even more adjustments to your rate, as these two areas were a major contributor to the recent foreclosure wave.
The fact here is that your loan originator is now required to do a lot more research into each loan before they can even give you a quote. At first glance the new rules and adjustments can seem discouraging to many borrowers, but the fact is the market is finding its way through this new economy and, in the end, the goal isn’t to turn borrowers away but to slow the process down and insure you have the most suitable product for your needs.