Understanding Mortgage Rates & How They Affect Home Loans | MoneyGeek

Guide to Today's Mortgage Rates

Mortgage rates have been near record lows for a decade, since dropping below 5 percent back in 2010. Rates hit their historical lows in late 2012, when 30-year fixed rates averaged 3.31 percent, according to Freddie Mac. Rates have risen slightly since then, but for those who remember the double-digit mortgage rates of the 1980s, today's levels seem almost comically low. Freddie Mac says the 30-year fixed-rate mortgage averaged 3.78 percent during the week of Oct. 31, 2019. With rates that low and with the job market strong, now could be the perfect time to lock in a low rate with a new mortgage or save with a refinance.

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What Affects Your Mortgage Rate?

Today's mortgage rates are driven by several factors. Some of them are under your control, and some are not. To get the best rate, you'll want to control what you can and compare offers from competing lenders.

Top 10 Factors That Influence Your Mortgage Rate

1 Credit Score

This is one of the main factors you can control. Mortgage borrowers FICO scores of 740 or higher usually get the best rate. The rate on a 30-year fixed mortgage is about .50 percent lower than those with FICO scores of 640, according to Fannie Mae.

2 Down Payment/Equity

The more money you put down when you buy your house (or the more equity you have when you refinance), the lower your mortgage rate will be. With less than 20 percent equity, private or government mortgage insurance premiums can add what is in effect about 0.2 to 2.0 percent to your interest rate, depending on the down payment, FICO score, property characteristics and loan program.

3 Loan Terms

A loan's terms affect its risk. Features such as interest-only payments increase the chance of default and come with higher rates. Loans with shorter terms (15 years, for example), are safer for lenders, so their rates are lower. Adjustable-rate mortgages (ARMs) are desirable for lenders because if inflation hits, they can increase rates. For this reason, lenders offer lower rates to people who choose ARMs over fixed loans.

4 Points

The more you pay for your home loan, the lower your interest rate should be. Mortgages are priced three ways: "par," which means you pay origination costs; "rebate," which allows the lender to cover the origination (and perhaps other fees) by charging you a higher rate; and "discount" or "premium" pricing, in which you pay higher fees upfront, called "discount points," to get a lower rate and payment. Keep in mind that the best deal is not always the one with the lowest rate.

5 Property Location

It costs lenders less to lend in some states than others. Your rate is influenced by your state's average historical loan performance, the amount of local competition for mortgage business, and foreclosure laws that make repossessing a home easier or more difficult.

6 Property Use

Loans against primary residences are less likely to end up in foreclosure than loans secured by vacation properties or rentals. For this reason, it costs less to borrow against your main residence than it does to finance a second home. In addition to higher fees, loans for riskier properties have stricter underwriting requirements; you may have to make a higher down payment or have more savings to qualify.

7 Property Type

Traditionally built (also called "stick built") single family homes usually get the best rates. Manufactured (mobile) housing, condos, co-ops, mixed-use developments and multifamily properties have historically higher default rates, so mortgages for those properties often cost more.

8 Loan Amount

Loans with very large or very small loan amounts cost more. Extra-large mortgages, called jumbo or super jumbo loans, have higher rates and stricter underwriting guidelines because they are harder to sell to investors. Small loans come with surcharges because it costs money to originate them, and small mortgages don't generate enough interest to cover the lender's costs.

9 Economy

Finances worldwide affect mortgage rates here at home. When the world economy is shaky, investors move their money into American bonds and mortgage-backed securities (MBS), and this demand pushes American interest rates lower. On the flip side, when the economy heats up, investors worry about inflation and demand higher returns from bonds and mortgage-backed securities. This forces rates higher.

10 Volume of Mortgage Applications

When interest rates drop, lenders are swamped with applications. They can only process and fund so many loans, so when volume rises too high, they raise rates to slow down the flow. The opposite is also true. When business slows down, lenders squeeze their profit margins a little and drop rates to bring in more business.

You can't control every factor influencing mortgage rates. But you can control the type of property you buy, the amount of your down payment, your credit score, the points you pay and loan you choose. To get the most competitive rates for your profile, it's important to compare several quotes from competing lenders and choose the best offer.

Shopping for the Best Rate

Mortgage lenders are independent companies that set rates to suit their own business goals, and on average, rates vary between lenders by 0.25 to 0.5 percent. It's up to you to find the lower rates with some smart shopping.

How much can you save? A large amount! If you borrow $400,000 with a 30-year fixed-rate mortgage at 3.75 percent, your monthly principal and interest is $1,852. At 4.25 percent, the principal and interest jumps to $1,968 — $115 more. Over five years, you could save almost $7,000 simply by taking a few minutes upfront to get quotes from several lenders.

Once you have competing bids in hand, don't be afraid to negotiate. The credit scoring firm Fair Isaac Co., the creator of the FICO credit score, says the higher your score, the more bargaining power you have. If one lender's loan package lacks something a competitor offers you, let the loan officer know. The lender may be willing to tweak the original offer. When shopping for mortgage quotes, consider a credit union. In his book Mortgage Confidential, David Reed calls credit unions "a little-known secret source of mortgage money at very competitive interest rates." Because credit unions are nonprofit cooperatives owned by their members, they may offer better deals than for-profit lenders. However, not every credit union offers every program, and some may have conservative underwriting standards.

Why the Lowest Rate Isn't Always the Best Deal

Faced with a confusing menu of choices and fees, overwhelmed borrowers often simplify their decision by focusing on the rate. That's a crucial part of the home loan, but it's not the only factor. Closing costs can add up fast, so scrutinize this part of your mortgage. When you take out a loan, you're also footing the bill for a variety of expenses, including an appraisal, a credit report, a survey and a flood risk report, plus fees for processing, administering and underwriting your loan. Because these fees can come in all over the map, the federal government requires lenders to provide a Good Faith Estimate detailing the costs you'll pay at closing. This is another reason to shop around: Compare closing costs, and if you find a big difference, try to negotiate a better deal.

Sometimes, lenders try to woo you with a rock-bottom rate and hope you don't notice that their fees are higher. That's why it's important to shop around and get multiple Good Faith Estimates (also called a Consumer Financial Protection Bureau Loan Estimate). If one offer comes with a quote that is a quarter-point lower than the others, pay special attention to the administrative charges such as application fee, underwriting fee and processing fee. It's possible that the lender is making up for the lower rate with higher fees.

Understanding APR

Let's say you requested quotes from four lenders, and now you're facing four bids. It's unlikely the proposals are identical in every detail, so how do you judge which is the best deal? Some experts recommend using the annual percentage rate (APR) to compare quotes. The federal Truth-in-Lending Act requires lenders to disclose the APR. The APR includes the total financing costs, including the basic interest rate, lender fees and points. The idea behind the APR is that it helps you compare offers with different rates and pricing, putting them on the same playing field.

The APR has both advantages and disadvantages. On the plus side, the APR can give you a more accurate picture of the overall costs of your loan. Still, APRs can be misused and misunderstood. For starters, the APR is a useful tool only if you're comparing identical loans. You can't compare a 15-year loan to a 30-year loan or a fixed loan to an ARM. Another limit to APRs: they're accurate only if you keep the loan for its entire term — something that rarely happens. If you sell or refinance before a 30-year mortgage ends, points and fees will be spread out over fewer years, so a loan with high upfront costs may end up being quite expensive, even if its rate is low.

Should You Pay Points?

Is your head spinning yet? Here's another factor to consider: points. A point equals 1 percent of the loan amount. If you borrow $200,000, a point costs $2,000. The idea is that the more you pay upfront, the lower your interest rate and monthly payment should be. "Discount points" are paid by the borrower to lower the interest rate. "Rebate points" are paid by the lender to cover such items as closing costs and escrow funding, but they lead to a higher interest rate over the life of the loan. It can be complicated. In March 2015, Jack Guttentag, creator of the Mortgage Professor website, wrote that he found 17 combinations of points and rates for a single 30-year fixed-rate loan.

With so many choices, which is the right one for you? That all depends on your situation. If you expect to stay in a home for three years, a higher interest rate won't hurt much, especially if it's offset by rebate points that cover your closing costs. What if you plan to keep your mortgage for 10 years? In that case, it might be wise to pay a point or two now in exchange for lowering your next 120 payments. Your cash cushion is another factor to consider. If cash is so tight that your down payment and closing costs will leave you eating ramen for the foreseeable future, rebate points could make sense. If you're more concerned about sticking to a monthly budget, then discount points could provide more breathing room. If you don't know how long you'll keep your loan, some experts advise avoiding them. "I suggest taking that same $2,000 and paying your principal down directly," writes Reed in Mortgage Confidential. "Or you could simply keep it."

Mortgage Points Questions and Answers

Pava Leyrer, chief operating officer of Northern Mortgage Services in Michigan, answers common questions about paying points for your mortgage.

What is a point?

A point is 1 percent of the amount of the loan, paid upfront, to "buy down" the interest rate on your loan. Points represent a trade-off: Pay now to lower your payments in the future, or skip the points and pay slightly higher rates in the future. "If today's rate is 4 percent and you really want 3.75 percent, you can pay a point to get the lower rate," Leyrer says.

Should I pay points to lower my rate?

That depends. Every borrower's cash, budget and plans are unique. "This is your loan and your life, so I try not to tell people what to do," Leyrer says. That said, when rates are high, the points might push an out-of-reach payment into the range of affordability. Years ago, Leyrer herself paid two points so she and her husband could squeak into a larger loan. Borrowers also must consider how long they'll stay in the house. If you plan to be there for a decade, the lower payments might offset the upfront costs of paying the points. If you're leaving in a few years, you might not keep the loan for long enough to make the points a smart investment.

How do I walk through the numbers?

If, for example, you borrow $200,000 for 30 years at a fixed rate of 4 percent, your monthly principal and interest payment is $955. But if you pay $2,000 to drop the rate to 3.75 percent, your monthly payment falls to $926. Saving $29 a month, it would take nearly six years for you to recoup the upfront cost of the point.

What if the seller is paying the points?

In that case, it's a no-brainer. Many sellers in Midwestern housing markets offer to pay closing costs totaling 2 to 6 percent of the amount of the sale, Leyrer says. It's a way to smooth the deal and guarantee the seller can find a buyer. If you've already used the seller incentive to pay for your appraisal, inspection and other transaction costs and you still have money left over, it makes sense to devote that cash to lowering your future payment.

Is there any downside to paying points?

The main disadvantage is that you'll have to come up with the cash. Paying one point on a $200,000 loan sucks an extra $2,000 out of your pocket. The other potential disadvantage is that if you sell or refinance sooner than you expect, you might not have your loan long enough for the monthly savings to cover the upfront cost of points.

Is there a tax advantage to paying points?

Quite possibly. "Check with your CPA, but some of that can be a write-off on your taxes," Leyrer says. The IRS allows homeowners who itemize to deduct mortgage interest, and Uncle Sam considers discount points to be prepaid interest. As with anything involving the IRS, there are caveats. Points covering items usually listed separately on the mortgage settlement sheet, such as origination charges, appraisal fees or other loan-related costs, are not prepaid interest and not deductible as such. Deductible points must be a percentage of the loan amount, and they must be paid to finance your main home. They must not exceed customary charges in your area to be deductible.

Understanding Where Rates Come From

You don't need a finance degree to get a mortgage, but it is worth understanding at least a bit about how mortgage rates are set and what happens to your loan after it closes. Although neither the Federal Reserve nor the U.S. Treasury set mortgage rates, their actions can influence what you pay.

The Fed and the mortgage market coexist in the same overall economy, and mortgage rates tend to move in the same general direction as the federal funds rate — but that does not mean one causes the other. The Fed's main tool always has always been setting short-term rates, and fixed-rate mortgages are decidedly not short-term loans. Instead, prices for fixed-rate mortgages are set in the corresponding bond markets — i.e.,30-year mortgage bonds for 30-year loans and 15-year mortgage bonds for 15-year loans.

Historically, the Fed has had a more direct effect on ARMs because ARMs are short-term loans that typically reset once a year. But the Fed doesn't directly set ARM rates. Instead, the rates are typically based on one of four underlying indexes — six-month treasury bills, 12-month treasury bills, the 11th District Cost of Funds Index (COFI), or the London Interbank Offered Rate (LIBOR).

The Great Recession introduced a new wrinkle and sort of changed the rates' environment. Faced with the worst crisis since the Great Depression, the Fed embarked on a campaign to stimulate the economy through the purchase of mortgage and Treasury bonds in a measure known as quantitative easing (QE). Up until recently, the Fed was spending about $85 billion in bond purchases per month, helping keep mortgage rates low. Most mortgages in the US are sold by lenders to the government-sponsored enterprises Fannie Mae and Freddie Mac, bundled together with similar mortgages, then sold to investors as bonds.

When the demand for bonds increases, bond prices rise, and yields (the rates of return to investors) fall. By buying mortgage-backed securities, the Fed raised prices and pushed down yields. Whenever mortgage bond yields and the yields on 10-year Treasury bonds fall, mortgage rates tend to follow in the same direction,

While the QE program winds down, most observers think the shift is unlikely to send rates soaring. "Ending QE isn't putting on the brakes," writes Peter Coy, economics editor at Bloomberg BusinessWeek. "It's just easing off the accelerator." Coy compares mortgage-backed securities to bottles of sunscreen at a beach resort. If there are only 10 bottles in stock and the Fed snaps up nine, the price on the last bottle will increase, right? (Remember, in the math of the bond market, higher prices mean lower yields.) The Fed doesn't need to buy the 10th bottle to keep sunscreen prices high. It just needs to hang onto its hoard of the other nine bottles.

How Rates Have Changed Over the Years

This graphic shows you how much mortgage rates have changed over the last 20 years.

How much would your loan have cost you in the past? Enter your loan info to find out.
Loan Amount
Term of Loan (Years)
Payments Per Year
Your mortgage would have had a
interest rate
and monthly payments of

Other Factors that Affect Interest Rates

How can you tell if mortgage rates will rise or fall in the near future? You can't. But certain economic reports may give you a hint of where rates are headed. The monthly employment report from the U.S. Labor Department is one of the most widely watched indicators. Released the first Friday of every month, the jobs report is considered a harbinger of rate movements. When the job market is weak — reflected by a rising unemployment rate and tepid job growth — the Fed tries to stimulate the economy by lowering interest rates, therefore making it cheaper for consumers and businesses to borrow money. When the job market is strong, the Fed aims to take some of the life out of the party by making it more expensive to borrow. The Fed raised rates in December 2015 — the first increase in nearly a decade.

A disappointing jobs report can be good news for borrowers. For instance, after a lackluster report in April 2015, many market watchers said the Fed would prove less eager to raise rates. True to the script, mortgage rates fell. In the week after the disappointing jobs report, the average 30-year fixed-rate mortgage dipped to 3.66 percent from 3.7 percent, according to Freddie Mac.

Generally, a weak jobs report also makes investors less confident. Whenever investors are nervous about the economy, they tend to pull money out of riskier investments, such as the stock market, to see the safety of Treasury bonds. The increased demand for bonds generally pushes mortgage rates down.

The opposite happens after a strong jobs report is released, as investors gain confidence in the economy and are more willing to bet on riskier investments. Robust job growth, while good for the overall economy, also may push borrowing costs higher as the Fed seeks to reduce the risk of inflation. The job market is just one factor influencing mortgage rates, and the relationship isn't always a clear one. Despite a year of robust job growth, mortgage rates fell from April 2014 to April 2015.

Other economic reports also influence rates, including quarterly gross domestic product estimate (GDP). A fast-growing economy typically leads to higher mortgage rates, while slow growth tends to push rates down. The Conference Board's monthly Consumer Confidence Index and the Institute for Supply Management's manufacturing report give additional readings on the direction of the economy.

The global economy also plays a role in mortgage rates. The U.S. economy's reputation as a safe haven means money pours into Treasury securities from China and elsewhere, keeping rates low. And foreign demand for U.S. mortgage-backed securities keeps rates low here. With the European economy in constant crisis in recent years, the flight-to-quality effect has continued.

Should You Lock or Float?

What is a rate lock?

When you ask your mortgage broker or loan officer to lock in a rate, you're requesting the lender to honor today's rate for the time it takes you to get to the closing table. Lock periods range from seven to 180 days, with the most typical being 30 days. The longer your rate lock, the higher its cost. The rate for a 15-day lock might be 0.125 percent lower than that of a 30-day lock. Locks for longer periods also come with upfront fees — a 90-day lock, for example, might cost you 0.5 points upfront.

What if rates go up?

Congrats — you win. If you've locked in and rates go up, your lender has committed to giving you money at the going rate on the day you locked as long as you're within your lock period.

What if rates go down?

Then it gets tricky. The lock represents a commitment by you to borrow the money, which means the lender has taken your chunk of money off the table for other borrowers. For that reason, lenders tend to lose patience with mortgage brokers who back out of deals after locking in a rate. Tighter appraisal rules after the Great Recession make it harder for borrowers to break rate locks, writes Reed in Mortgage Confidential. That said, if rates fall after you've locked in, don't be afraid to ask for a lower rate. Before you lock, talk to your loan officer or mortgage broker about your options should rates fall after you lock. In the pre-crash days, you could change lenders without a new appraisal. After the crash, changing lenders means taking on the time and expense of ordering a fresh appraisal.

Can I float my rate?

You can float your rate right up until the time your lender draws your loan documents if you want. The advantage is that you'll only have to lock for a few days and might get a better rate. Of course, the downside is that rates go up, too, and you might get stuck with one you don't like. Some lenders offer "float-down" options that let you lock in the "going rate" on your loan, and if that rate is lower when it's time to close, you get the better deal. As with everything else in the mortgage market, this option comes with trade-offs. For starters, float-down provisions often kick in only if rates drop by a quarter point or more. And lenders that offer float-down options often quote slightly higher rates or require you to pay an upfront fee.

What happens if I don't close on time?

It depends. If you lock a loan for a specific period and don't get your loan closed within that period, your lock is said to have "blown." If rates are the same, your lender can often extend it for a few days or relock it at no charge. If rates have risen, however, you may have to relock at the higher rate or pay to extend your lock. And if rates have fallen, you'll be able to extend your original lock, probably at no charge.

Fixed or Adjustable Rate Loan?

Do you prefer to play it safe? Or, as Dirty Harry once asked, "Do you feel lucky?" Fixed-rate mortgages are easy to understand. You choose your rate, and that's what you get for the entire term of the loan.

ARMs are more complicated. However, they're worth understanding because they come with lower interest rates than fixed loans. These rates are not permanent; they are called "start rates" or "introductory rates," and eventually they can change. ARM start rates can be effective for one month to 10 years, depending on the loan. The period in which the start rate is in effect is called the "introductory period."

The name of an ARM tells you a lot about its rate. A 5/1 Libor ARM, for example, has a rate that's based on the Libor index, is fixed for five years and then resets every year after that. It's the most popular ARM. A one-month COFI ARM is based on the COFI index and can adjust every month.

Adjustable-Rate Mortgages (ARMs)


ARMs offer lower rates and smaller payments initially. If you expect to earn more in a few years, this can help make your home affordable in the beginning, when your income is lower.

ARMs let borrowers reap the rewards of falling rates without a costly and time-consuming refinance.

ARMs let you save and invest more money. If an ARM knocks $50 a month off your payment compared to a fixed-rate mortgage, you could set aside that cash for retirement or your kids' college savings.

If you don't plan to stay in your house for long, an ARM is cheaper. Rates for 5/1 loans generally run about 1 percent lower than those of 30-year loans. In five years, the savings could be enough to buy a car.


The rates on ARMs can increase by 1 or 2 percent per year to a maximum of 5 or 6 percent over your start rate. If rates skyrocket, your payment could become unaffordable.

With mortgage rates near record lows, the Fed stimulus winding down and the economy heating up, experts say rates are more likely to rise than fall.

ARMs can come with a confusing array of features that can be overwhelming for new borrowers.

Fixed-Rate Mortgages


There are no surprises. Rates and payments stay the same for the life of the loan, so if you're not inclined to follow the gyrations of the financial markets, you don't have to.

The certainty — your principal and interest payment stays the same for the life of the loan, making budgeting easier.

Unlike ARMs, fixed-rate mortgages are simple to understand.


In the early years of a 30-year fixed-rate mortgage, you'll pay a lot of interest while barely denting your principal.

If rates fall, you'll need a costly and time-consuming refinance to take advantage.