How Mortgages Work

Industry Observer with CDK Global

How Mortgage Rates Work

blog by: Erin Oertli, Member Services at Active Rain, Seattle WA

How Mortgage Rates Work is a question that every consumer is faced with when purchasing a home, refinancing, or just plain inquiring.   How many times have you asked yourself ‘Where do banks and mortgage companies get these rates?  Out of the sky, depending on their mood or time of day?!?’  Every time someone sees that the Fed cut rates, they call their mortgage representative and ask what rate they could get, assuming that Mortgages Rates Work that way.  Trying to explain to a consumer that mortgage rates are higher than the Fed, especially when the Fed is practically 0% can be a disheartening task. 


That brings me to my next point--does a Fed rate cut really mean that mortgage rates will follow?  The answer is bound to shock the majority of consumers.  The Fed only controls the Discount Rate and the Fed Funds Rate.  These rates are very different than the mortgage rates and how they work. Keep in mind that a mortgage rate can be in effect for 30 years and the rate set by the Fed changes from one day to another. 

Another common mistake is thinking that the 30 year Treasury bonds or 10-year Treasury notes directly correlate with mortgage rates.  Ok, so now we went over the most common myths, let’s get to the bottom of how mortgages work.

So what are they based on, you’re screaming?!  Mortgage rates are based upon Mortgage-Backed Securities (MBS).  These bonds are issued by Fannie Mae and Freddie Mac and the trading potential they have will determine the direction the mortgage rates go.

What does that mean for me, you may be asking--this means that inflation will always affect any long-term bond negatively because of the future returns.  They will end up paying a less valuable set amount over time because of the inevitability of inflation rising.  The only thing that may offset this would be the more broader stock market such as Nasdaq.

Try to think of it like a balancing act; if bond prices rise, mortgage rates fall and as bond prices fall, mortgage rates rise.  In summary, it would appear that mortgage rates will improve if the Nasdaq sells off and will ultimately worsen if the Nasdaq does well.  So, it’s not necessarily what the Fed does that directly affects mortgage rates, it has more to do with the broader stock market which interprets the Fed’s action that will then influence the direction of mortgage rates.

Ok, now you can call up your mortgage representative and tell them what you know; you will blow their minds!

Comments (1)

Carlos Morales
Re/Max Homes and Estates - Irvine, CA

Thanks for the information, this should help homeowner and future buyers to understand better the mortgage industry.


Sep 01, 2009 03:57 AM