Timing the market for the best possible opportunity to lock a mortgage rate on a new loan is certainly a challenge, even for the professionals.
While there are several generic interest rate trend indicators online, the difference between what’s advertised and actually attainable can be influenced at any given moment by at least 50 different variables in the market, and with each individual loan approval scenario.
Outside of the borrower’s control, the mortgage rate marketplace is a dynamic, volatile, living and breathing animal.
Lenders set their rates every day based on the market activities of Mortgage Bonds, also known as Mortgage Backed Securities (MBS).
On volatile days, a lender might adjust their pricing anywhere from one to five times, depending on what’s taking place in the market.
Factors That Influence Mortgage Backed Securities:
1. Inflation –
According to Wikipedia:
In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, annual inflation is also an erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy.
A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.
As inflation increases, or as the expectation of future inflation increases, rates will push higher.
The contrary is also true; when inflation declines, rates decrease.
Famous economist Milton Friedman said “inflation is always and everywhere a monetary phenomenon.”
Public enemy #1 of all fixed income investments, inflation and the expectation of future inflation is a key indicator of how much investors will pay for mortgage bonds, and therefore how high or low current mortgage rates will be in the open market.
When an investor buys a bond, they receive a fixed percentage of the value of that bond as ‘coupon’ payments.
With MBS, an investor might buy a bond that pays 5%, which means for every $100 invested, they receive $5 in interest per year, usually divided up over 12 payments. For the buyer of a mortgage bond, that $5 coupon payment is worth more in the first year, because it can buy more today than it can in the future, due to inflation. When the markets read signals of increasing inflation, it tells bond investors that their future coupon payments will be less valuable by the time they receive them. So basically, this causes investors to demand higher rates for any new bonds they invest in.
As part of its 2008-2010 stimulus effort, the NY Fed spent almost all of its $1.25 trillion budget buying mortgage bonds. Many believe this strategy kept mortgage rates lower over a 15 month period.
The lending environment significantly changed between 2008, when the Fed began its mortgage bond purchasing program, and early 2010 when the market was left to survive on its own.
When the MBS purchase program was announced in November 2008, mortgage bonds reacted immediately and dramatically.
But at that time, there weren’t any investors willing to take a risk in buying mortgage bonds. The meltdown in the mortgage market and world economies lead many investors to shy away from the risks associated with MBS, which is why the Fed had to step in and basically assume the role as the sole investor of mortgage bonds.
However, loan underwriting guidelines drastically tightened up by 2010, which may create a little more confidence in the mortgage bond market.
3. Unemployment –
Decreasing unemployment will suggest that mortgage rates will rise.
Typically, higher unemployment levels tend to result in lower inflation, which makes bonds safer and permits higher bond prices. For example, the unemployment rate in March 2010 was at 9.7%, just slightly below its highest mark in the current economic cycle.
Every month, the BLS releases the Nonfarm Payrolls (aka The Jobs Report) which tallies the number of jobs created or lost in the preceding month.
The previous report indicated a loss of 36,000 jobs. Not necessarily a number that will move the needle on the unemployment gauge, but some economists suggest we need about 125,000 new jobs each month just to keep pace with population growth. So that negative 36,000 is more like negative 161,000 jobs short of an improving unemployment picture.
One flaw to pay attention to with unemployment rates is that the method of surveying fails to capture part-time workers who desire full-time employment, discouraged job seekers who have taken time off from searching and other would-be workers who are not considered to be part of the labor force.
4. GDP –
GDP, or Gross Domestic Product, is a measure of the economic output of the country.
High levels of GDP growth may signal increasing mortgage rates.
The Federal Reserve slashes short-term rates when GDP slows to encourage people and businesses to borrow money. When GDP gets too hot, there might be too much money floating around, and inflation usually picks up. So high GDP ratings warn the market that interest rates will rise to keep inflation concerns in balance.
Spiking GDP with flat/increasing unemployment begs some questions.
There are two major indicators that help provide more context:
1. Increases to worker productivity – employers are getting more work out of their current employees to avoid hiring new ones
2. Surges in inventory cycles – when the economy first started contracting, manufacturing slowed down to cut costs, and sales were made by liquidating inventory.
This is like a roller coaster cresting a hill, where one part of the train is going up, the other down. Eventually, the other side catches up, inventories are rebuilt by manufacturing more than is being sold. Both surges can throw off periodic reports of GDP.
5. Geopolitics –
Unforeseen events related to global conflict, political events, and natural disasters will tend to lower mortgage rates.
Anything that the markets didn’t see coming causes uncertainty and panic. And when markets panic, money generally moves to stable investments (bonds), which brings rates lower. Mortgage bonds pick up some of that momentum.
Acts of terrorism, tsunamis, earthquakes, and recent sovereign debt crises (Dubai, Greece) are all examples.
Putting It All Together:
Economic data is reported daily, and some items have a greater tendency to be of concern to the market for mortgage rates. If you are involved in a real estate financing transaction, it’s helpful to be aware of these influences, or to rely upon the advice of a mortgage professional who is already dialed in.
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When shopping for a new mortgage loan, you may notice an Annual Percentage Rate (APR) advertised next to the note rate. The inclusion of an APR is actually mandated by federal law in order to help give borrowers a standard rule of measurement for comparing the total cost of each loan.
The APR is designed to represent the “true cost of a loan” to the borrower, expressed in the form of a yearly rate to prevent lenders from “hiding” fees and up-front costs behind low advertised rates.
According to Wikipedia:
The terms annual percentage of rate (APR) and nominal APR describe the interest rate for a whole year (annualized), rather than just a monthly fee/rate, as applied on a loan, mortgage, credit card, etc. It is a finance charge expressed as an annual rate.
- The nominal APR is the simple-interest rate (for a year).
- The effective APR is the fee+compound interest rate (calculated across a year)
The nominal APR is calculated as: the rate, for a payment period, multiplied by the number of payment periods in a year.
However, the exact legal definition of “effective APR” can vary greatly, depending on the type of fees included, such as participation fees, loan origination fees, monthly service charges, or late fees.
The effective APR has been called the “mathematically-true” interest rate for each year. The computation for the effective APR, as the fee+compound interest rate, can also vary depending on whether the up-front fees, such as origination or participation fees, are added to the entire amount, or treated as a short-term loan due in the first payment.
What Fees Are Typically Included In APR?
- Origination Fee
- Discount Points
- Buydown funds from the buyer
- Prepaid Mortgage Interest
- Mortgage Insurance Premiums
- Other lender fees (application, underwriting, tax service, etc.)
Since origination fees, discount points, mortgage insurance premiums, prepaid interest and other items may also be required to obtain a mortgage, they need to be included when calculating the APR. Fees such as title insurance, appraisal and credit are not included in calculating the APR.
The APR can vary between lenders and programs due to the fact that the federal law does not clearly define specifically what goes into the calculation.
What Does APR Not Disclose?
- APR on a loan tied to a market index, like a 5/1 ARM, assumes the market index will never change. But Adjustable Rate Mortgages always change over the course of 30 years.
- Balloon Payments
- Prepayment Penalties
- Length of Rate Lock
- Comparison between loan terms – EX: A 15-year term will have a higher APR simply because the fees are amortized over a shorter period of time compared to a similar rate / cost scenario on a 30-year term.
APR Comparing Examples:
- Bank (A) is offering a 30 year fixed mortgage at 8.00% APR
- Bank (B) is offering a 30 year fixed mortgage at 7.00% Note Rate
Easy choice, right?
While Bank (B) is advertising the lowest Note Rate, they’re not factoring in the origination points, underwriting / processing fees and prepaid mortgage interest (first month’s mortgage payment), which could essentially make the APR much higher than the one Bank (A) is advertising. So Bank (A) may show a higher rate due to the APR, but they could actually be charging a lot less in total fees than Bank (B).
Before lenders and mortgage brokers were required to state the APR, it was more difficult to find the truth about the total borrowing costs of one loan vs another. When comparing mortgage rates, it’s a good idea to ask your lender which fees are included in their APR quote.
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Many people believe that interest rates are simply set by lenders, but the reality is that mortgage rates are largely determined by what is known as the Secondary Market.
The secondary market is comprised of investors who buy the loans made by banks, brokers, lenders, etc. and then either hold them for their earnings, or bundle them and sell them to other investors. When the secondary market sells the bundles of mortgages, there are end investors who are willing to pay a certain price for those loans.
That market price of those Mortgage Backed Securities (MBS) is what impacts mortgage rates.
Typically, investors are willing to accept a lower return on mortgage backed securities because of their relative safety compared to other investments.
This perception of safety is due to the implied government backing of Fannie Mae and Freddie Mac and the fact that the Mortgage Backed investments are based on real estate collateral. So, if the loan defaults there is real property pledged against potential losses.
In contrast, other investments are considered more risky, specifically stocks which are based on earnings and profit vs real property. The movement between the two investment vehicles often dictates mortgage rates.
Why Do Mortgage Rates Change?
Mortgage rates fluctuate based on the market’s perception of the economy.
Stocks are considered riskier investments, and therefore have an expected higher rate of return to compensate for that risk. When the economy is thriving, it is presumed that companies will perform better, and therefore their stock prices will move higher. When stock prices move higher – MBS prices generally move lower. Mortgage Backed Securities, however, thrive when the economy is perceived as not doing well. When investors forecast a faltering economy, they worry that the return on stocks will be lower, so they frequently engage in a ‘flight to safety’ and buy more secure investments such as Mortgage Backed Securities. Mortgage rates are actually based on the yield of those Mortgage Backed Securities.
Bonds are sold at a particular price based on their value in relation to other available investments. When a bond is sold it yields a certain return based on that original purchase price. As the prices of the MBS increases because investors seek their safety, the yield decreases. Conversely, when investors seek the higher returns of stocks and the MBS are purchased in lesser quantities the price goes down. The lower price results in a higher yield, and this yield is what determines mortgage rates.
How Would I Know if Rates are Expected to Go Up or Down?
When the economy is growing or is expected to grow, stocks will likely become the more favored investment.
When investors buy more stocks, they purchase fewer MBS, which drives the price down.
When the price of the MBS is lower, the yield increases.
Since mortgage rates are based on the yield of the 30 Year MBS, you would expect rates to increase in this environment.
When the economy appears to be slowing or is doing poorly, investors typically move their money out of the stock market and into the safety of the MBS.
This drives the price of these investments higher, which results in a lower yield.
Since mortgage rates are based on the yield of the 30 Year MBS, you would expect rates to decrease in this environment.
Since these market variables and expectations change multiple times as economic reports are released throughout the course of a week, it is not uncommon to see mortgage rates change several times a day.
Understanding how rates move is not necessarily as important as having a loan officer that is equipped with the technology and professional services to track and stay alerted at the precise moment rates make a move for the better or worse.
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Lower mortgage rates is a common misconception that is perpetuated by the mainstream media when the Fed makes an announcement of lowering rates.
However, when the Fed cuts interest rates, mortgage rates can actually increase.
According to Wikipedia:
The Federal Reserve System (also known as the Federal Reserve, and informally as the Fed) is the central banking system of the United States.
This system was conceived by several of the world’s leading bankers in 1910 and enacted in 1913, with the passing of the Federal Reserve Act. The passing of the Federal Reserve Act was largely a response to prior financial panics and bank runs, the most severe of which being the Panic of 1907.
Over time, the roles and responsibilities of the Federal Reserve System have expanded and its structure has evolved. Events such as the Great Depression were some of the major factors leading to changes in the system.
Its duties today, according to official Federal Reserve documentation, fall into four general areas:
- Conducting the nation’s monetary policy by influencing monetary and credit conditions in the economy in pursuit of maximum employment, stable prices, and moderate long-term interest rates.
- Supervising and regulating banking institutions to ensure the safety and soundness of the nation’s banking and financial system, and protect the credit rights of consumers.
- Maintaining stability of the financial system and containing systemic risk that may arise in financial markets.
The Federal Reserve controls two key interest rates in this country:
These are overnight lending rates used by banks when they lend money to each other.
When these rates are low, money is cheaper for banks to borrow, and that “cheap” money spreads throughout the economy.
The aim of the Federal Reserve in its interest rate policy is to either speed up or slow down the economy. In times of economic downturn, the Federal Reserve will cut rates to help create a boost. Conversely, in times of heavy inflation, the Fed will raise rates to help slow down the economy.
That’s it; speed up or slow down….no tricks.
When the credit crisis began to spiral in 2007, the Fed cut rates dramatically in hopes of jump-starting the economy. The Fed keeping rates near zero is an indication that the economy is moving along at a steady pace. If the economy improves to the point where inflation starts to creep up the Fed will begin hiking rates.
The Fed and Mortgage Rates:
Mortgage rates are tied to mortgage bonds, which are traded every day on the secondary market just like stocks.
Bonds are often considered a safer investment than stocks since they yield a constant rate of return.
During times of market turmoil, investors sell their stock holdings and move into bonds (called a “flight to safety” in financial jargon).
Conversely, when the economy is booming, investors move their money away from bonds and into stocks to take advantage of the upswing in the economy.
Remember, The Fed cuts interest rates to boost the economy.
When investors see this boost, they sell their bond holdings and move into stocks.
This movement causes the rates on those bonds to increase naturally as the bonds have to attract new investors with higher rates of return.
As a result, we see mortgage rates increase.
So, the next time you hear the Fed cutting interest rates, don’t assume mortgage rates will simply follow suit. The rate cut is simply meant to boost the economy, which moves money from bonds to stocks, and causes mortgage rates to rise.
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Simply checking online for today’s posted rate may not lead to your expected outcome due to the many factors that can cause each individual rate and closing cost scenario to fluctuate.
We can preach communication, service and education all day long, but it’s our ultimate goal to earn your trust so that you can be confident in our ability to successfully lead you through this complex mortgage process.
Since mortgage rates can change several times a day, the following questions will help determine whether or not your lender truly knows what to look for so that they can provide you with the best rate once you’re in a position of locking in your loan:
Who determines mortgage rates, and what are they tied to?
Mortgage interest rates are determined by the pricing of Mortgage Backed Securities or Mortgage Bonds. The media often implies mortgage rates are based off the 10-year Treasury Note, which is incorrect.
While the 10-year Treasury Note has been known to trend in the same direction as Mortgage Bonds, it is not unusual to see them move in completely opposite directions.
How often do mortgage rates change?
Mortgage rates may change throughout the day, however they only change on days when the Bond markets are trading securities since mortgage rates are based on Mortgage Bond prices.
Think of a Mortgage Bond’s sales price similar to that of a Stock that trades up and down during the course of a day.
For example – let’s assume the FNMA 30-Year 4.50% coupon is selling for $100.50. The price is 50 basis points lower from the previous day’s closing price of $101.00.
In simple terms, the borrower would have to pay an additional .50% of their loan amount to have the same rate today that they could have locked in the previous day.
Mortgage Bonds are largely affected by various market forces that influence the changing demand for bonds within the market. Some of the key economic factors that have the greatest impact are unemployment percentages, inflationary fears, economic strength and the overall movement of money in and out of the markets.
Like stocks, most fluctuation is caused by consumer and investor emotions.
What do you use to monitor mortgage rates?
There are several great subscription based services available to monitor Mortgage Bond pricing.
The key is to make sure the lender is aware they should be monitoring Mortgage Bond pricing, such as the Fannie Mae 30-Year 4.50% coupon… and not the 10-Year Treasury Note or the news media.
It is a common misconception that when the Federal Reserve implements a rate cut it is immediately correlated to a reduction in mortgage rates.
The Federal Reserve policy influences short term rates known as the Fed Funds Rate (“FFR”). Lowering the FFR helps to stimulate the economy and increasing the FFR helps to slow the economy down. Effectively, cutting interest rates (FFR specifically) will cause the stock market to rally, driving money out of bonds and creating potential for inflation.
Mortgage Bond holders need to obtain a higher rate of return on their money if inflation is increasing, thus driving up mortgage rates. With the Federal Reserve Board meeting every six weeks, this is an important question to ask. If your lender does not have a firm understanding of this relationship, they may leave your rate unprotected costing you thousands of dollars over the life of your mortgage.
Do different programs have different interest rates?
Conventional, FHA and VA loans can all carry different rates on a 30-Year fixed mortgage. FHA and VA loans are insured by the Federal Government in the event of defaults. Conventional mortgages are insured by private mortgage insurance companies, if insurance is required.
Typically, FHA and VA loans carry a lower rate because the investor views the government backing as less of a risk. While rates are usually different for each program, it may be more important to compare the monthly and overall cost during the life of the loan to determine which program best suits your needs.
Why is an Adjustable Rate Mortgage (ARM) rate lower than a fixed rate mortgage?
An Adjustable Rate Mortgage (ARM) is usually fixed for a specific period of time. The period is typically 6 months, 1 year, 3 years, 5 years or 7 years. The shorter time period the rate is fixed, the lower the interest rate tends to be initially.
This is due to the borrower taking the future risk of increasing interest rates. The only instance where this would not be true is when there is an inverted yield curve where short-term rates are higher than long-term rates.
Why are rates higher for different property residence types?
Mortgage interest rates are based on risk-based pricing. Risk-based pricing allows adjustments to par pricing for risk factors such as; FICO scores, Loan-to-Value percentages, property type (SFR, Condo, 2-4 Units), occupancy (Primary, Vacation or Investment) and mortgage type (Interest Only, Adjustable Rate etc).
This allows the investors who lend their money for mortgages to receive additional compensation for taking additional risk.
If the borrower encounters a financial hardship, are they more likely to make the payment on the home they live in or the one they rent out?
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