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Shopping for a Mortgage: How Do Lenders Set Interest Rates?

Posted by  on Mar 30, 2010
 

Lenders don't really set interest rates. Mortgage rates are determined by the demand of investors for investments that are backed by mortgages. These investments are called mortgage-backed securities (MBS). When you take out a home loan, most likely it will be securitized, packaged with other mortgages, and then sold as an investment like stocks or bonds.

When the economy looks rocky and inflation is down, investors like the relative safety of bonds and MBS. Their prices increase, and mortgage interest rates drop. When economic growth and inflation are expected, investors require higher rates of return. MBS prices drop, and mortgage interest rates increase.

What Makes One Lender Offer Better Mortgage Rates than Another?

Lenders decide what they charge for loans based on a few things. First, there is the cost of the money, which is determined by MBS pricing. Then, the lender has its own costs--loan officers, processors, servicing departments, etc. A more efficient lender may be able to price a loan more competitively.

Sometimes, lenders may price their products at below market rates to increase their lending portfolios. This is only legal if done for a very short time, but if you catch the right lender at the right time, you can save money. This is one factor that makes shopping for your mortgage so important.

Other times, lenders increase pricing to stem the tide of mortgage applications--their staffing is not unlimited, and their funds are not infinite. If you only have so much to lend, and demand is high, you can charge more.

Finally, the level of service you get from your lender can impact its pricing. Less service can be cheaper, but be careful. A rock-bottom mortgage quote won't help if you blow your rate lock because your loan officer didn't return your calls or took too long to process your file.

Mortgage Quotes Aren't Cast in Concrete

Until your rate is locked, you don't have a firm offer. And every mortgage interest rate quote has this little disclaimer: "Rates and programs are subject to change without notice." So compare quotes, get your disclosures, and interview loan officers to find someone you trust.

Ultimately, the best home loan is more than a competitive rate--you close on time, your loan officer returns your calls, there are no surprises on your closing statement, you still have the hair you started with, and you aren't drinking any more than usual. That's a satisfactory mortgage experience.

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