How Are Mortgage Rates Determined?

Mortgage and Lending with Citywide Financial Corp

Mortgage rates are a very popular topic right now, as media channels across the US are telling everyone that interest rates are currently at record lows and now is a great time to afford a home. Understanding what determines a borrowers rate or what causes mortgage rates to go up or down is quite simple once you understand some basic economic fundamentals. So if anyone asks you "Why are rates so low" or "What will my rate be", or "Do you see rates increasing when I am ready to buy in a few months?", here is a quick guide to use that will help you answer some of these questions correctly.  

What Economic Events Force Rates to Go Up or Down? 

So what causes mortgage rates to go up or down? These are tied to some fundamental economic activities that take place everyday in our markets, by understanding these you will now be able to better predict and understand what direction rates will probably move. of the main reason mortgage rates are so low!

One of the main reasons US mortgage rates are so low right now is because of financial events in Europe. There is a debt contagion spreading throughout the countries of the European Union that is starting to unravel.

Greece, Portugal & Ireland have already requested bailouts, Italy and Spain are probably next in line. So why does the Euro crisis affect rates in the US? Anytime you hear of financial problems coming from Europe, this usually causes a "flight to safety" of investor money into US markets. 

A "flight to safety" occurs when overseas investors are nervous about owning European debt and risky assets like stocks, but do not want to miss out on earning a return on their funds, so they allocate money into risk-free U.S Treasury debt to provide a safe-haven AND an investment return. As Treasury yields fall, prices of mortgage bonds move higher which in turn lowers mortgage rates.

Stocks and bonds compete for investment 

Stocks and Bonds compete everyday for investors dollars in the open markets, stocks pay a higher rate of return so they are more risky, bonds have a lower return so they are seen as more stable and less risky. Remember: When there is weak economic news (European debt problems, higher unemployment etc), this normally causes money to flow out of Stocks and into more stable Bonds, helping Bonds and mortgage rates improve

But strong economic news (lower unemployment, more homes sold etc) normally has the opposite result, so investors will pull their money from bonds and put it into more risky stocks, thus causing mortgage rates to increase. It is an interesting dynamic that good economic news is bad for mortgage rates!

The Relationship between The Fed, Mortgage Bonds & Mortgage Rates  

The reason that mortgage rates move up or down everyday, is because Mortgage Bonds are traded everyday just like stocks. They either go up or down in price on a daily basis. Here is a mortgage bond trading chart below from the past 18 months. When mortgage bonds are trading higher, mortgage rates move lower, and when mortgage bonds trade lower, rates will move higher. As you can see below, mortgage bonds are currently trading at all time record highs!

When mortgage bonds trade lower, lenders raise their mortgage rates and republish these higher rates to the public. This daily trading of mortgage bonds directly correlates to the mortgage rates we see everyday from lenders. It is not unusual for mortgage rates to sometimes change 2 or 3 times in just one day!

Currently the Federal Reserve is artifically supressing rates by buying these mortgage bonds outright via their Quantitative Easing programs or "QE" as they are known, so this should keep rates from rising too much over the next year or two.

The Relationship between Credit Scores and Mortgage Rates    

It is no secret that having good credit scores are important for buyers in this market to score the best rates! For example, did you know a buyer with a 695 credit score purchasing a $400k home with 20% down, will pay an additional fee of 1.5% (see conventional risk pricing below) to get the same rate as a buyer with a 740 score, which amounts to an extra $4,800 the buyer has to pay at closing, or they can take a .375% higher interest rate instead that incorporates this 1.5% cost!


To maintain great credit, everyone should get a copy of their credit report once a year so they can make sure they are keeping their scores as high as possible, so when they are ready to obtain financing for anything, they are in a position to score the best rates! Here is a tip to obtain a free copy of your credit report, consumers are entitled to a FREE credit report once a year from

The Impact of Rising Rates on Buyer Affordability

Did you know that just a 1% increase in interest rates means a buyer loses 10% in purchasing power or affordability! Here is a great chart to share with your buyers, that shows if a buyer is shopping in a $400k price range today, if rates increase by just 1% the same buyer can now only afford $360k, a 10% drop in price! (*see how the payment at $400k with a rate of 3.5% is roughly the same as the payment at $360k with a rate of 4.5%).


A Look at mortgage rates over the past 40 years

I think it is important that buyers today understand where current rates are in relation to historical averages. For example, this chart below shows the average 30 year fixed mortgage rate over the past 40 years has been 8.7%, and 6.5% over the past decade! So for any buyers still on the fence looking at buying a home, they are very fortunate that they will be able to qualify for a rate that is at 40 year lows. 

Its important today's buyers understand Cost vs Price!

It is very important that today's buyers understand that waiting for a reduction in price is not the only way to get a great deal on a home. What is just as important is factoring in the overall cost to buy a home and that includes the interest rate and financing costs. Because as noted above, when rates increase by just 1%, buyers now lose 10% in purchasing power or affordability. 

There is no guarantee that interest rates are going to stay at the record low levels they are currently at, yes the Federal Reserve is artifically supressing rates by buying mortgage backed securities outright, but as the US economy continues to improve and add jobs, this means rates will also rise in tandem! For the 2nd week in a row now rates have increased and are now almost at 3.625% as of the second week in January, they were are at 3.375% just before the Christmas holidays. Therefore I believe we are at the bottom of the market in terms of "overall cost" to buy a home! 

P.S. If you have any questions about mortgage rates, feel free to contact me directly at 858-200-9602. Also if you would like to be updated faster on any new loan programs or important industry updates that come out, please join my Facebook page "Free Resources For Real Estate Agents". There are currently over 5,500 real estate professionals sharing tips and ideas on this page.


Best regards


Comments (49)

Grace Keng
Keller Williams Realty Cupertino - Cupertino, CA
CRS, CDPE (408) 799-8887

Great article. 1% interest affect 10% purchasing afforability.

Jan 12, 2013 02:40 AM
Bahman Davani, CM at Texas Five Star Realty, Plano, TX (214) 457-7055
Texas Five Star Realty, Plano Texas - Frisco, TX
Homes for Sale in Plano, Frisco, Prosper, Allen TX

I can't see the chart or picture under The Relationship between Credit Scores and Mortgage Rates      at, but I would like to have one. Could you please either re-blog or send me the picture at my email Also, if you have a very high resolution 200-year history of interest rate, I like to see one. Thanks. 

Jan 12, 2013 03:08 AM
Michael Deery
Citywide Financial Corp - Pacific Beach, CA

Thank you Steve, Andrew, Bahman and Rob for your feedback, I believe that understanding how rates are determined is something we all should be aware of.

Jan 12, 2013 03:15 AM
Michael Deery
Citywide Financial Corp - Pacific Beach, CA

Thank you for your feedback Lenn, my wife is an artist so when I tell her that she will be very happy :)

Jan 12, 2013 03:16 AM
Hella Mitschke Rothwell
(831) 626-4000 - Honolulu, HI
Hawaii & California Real Estate Broker
You explain it all so well. I'm going to keep your blog to show my clients.
Jan 12, 2013 03:21 AM
HomeSmart Real Estate - Phoenix, AZ

Very informative and interesting post, Michael. The information about Europe and why and how it affects our rates is useful and makes sense when you think of it...Also, the chart showing how rates and prices are affected. I have clients now that are on the fence because prices are rising in our market but if they're considering financing, and they are, then they really should think about the possibility of rising rates and that might convince them to buy now instead of later. Is there anywhere I can download and print out that chart?

Jan 12, 2013 03:33 AM
Jimmy Faulkner
Florida. Homes Realty & Mortgage - Wantagh, NY
The Best Of St. Augustine
Thank you. Jimmy. Faulkner
Jan 12, 2013 03:34 AM
Michael Deery
Citywide Financial Corp - Pacific Beach, CA

Hi Lynn, what is your email and I will send you the charts.

Jan 12, 2013 03:49 AM
Jana Holmstrup
Jana Holmstrup - CCO - Kings Mortgage Services, Inc. - Visalia, CA

Excellent job in simplifying a complicated subject.  Yes, of course, there's a lot more to it but, for the average homebuyer, this is what they need to know.  Well done!

Jan 12, 2013 04:15 AM
Dan Derito
Success! Real Estate - Brockton, MA

Thank you Michael. I'm going to print this out and give to clients to read at their liesure.  It is clear and concise in expaining in everyday terms what the mortgage process includes. 

Jan 12, 2013 10:01 AM
Sharon Parisi
United Real Estate Dallas - Dallas, TX
Dallas Homes


Thank you for putting together this comprehensive report on mortgage interest rates.  This is one of the most thorough explanations I have seen!

Jan 12, 2013 04:27 PM
Bob Miller
Keller Williams Cornerstone Realty - Ocala, FL
The Ocala Dream Team
Hi Michael we believe this is one of the best explanations we have ever seen! Great post!
Jan 12, 2013 10:39 PM
Cynthia Lowry
Brokers Guild Cherry Creek LTD - Centennial, CO

Dear Michael,

Thank you so much for the information that you shared in an easy to understand breakdown. I too would like to print and share with my clients. I am new to activerain and wanted to print and share but a couple charts didn't transpose. My email is


Thank you again and I look forward to reading more!


Kindest Regards,



Jan 12, 2013 10:52 PM
Michael Deery
Citywide Financial Corp - Pacific Beach, CA

Thank you for your your feedback Jimmy, Hella, Jana, Sharon, Bob and Dan, I appreciate your comments! Cynthia I will send you a copy of the charts today.

Jan 13, 2013 12:30 AM
Michael Deery
Citywide Financial Corp - Pacific Beach, CA

Can someone maybe explain to me why the charts keep disappearing off this page on Active Rain? Does not make sense.

Jan 14, 2013 02:51 AM
Rob Renk
Center Street Lending - McKinney, TX
AE | Fast Fix/Flip Loans for Residential Investors

Excellent explaination of how interest rates are determined.  The whole way that loans are priced is so complex now.  They try to make the simple complex.  Thanks for the share.

Jan 14, 2013 04:35 AM
Charles Stallions
Charles Stallions Real Estate Services - Pensacola, FL
800-309-3414 - Pensacola, Pace or Gulf Breeze, Fl.

A lot of information to absorb I started reading and now I will bookmark to finish later

Jan 30, 2013 06:31 AM
Michael Dagner
Brokers Guild Classic - Denver, CO
Your Denver Homes Realty Expert


An excellent primer on the basics of understanding mortgage interest rates.  Something to share with every client.   All the best!

Feb 06, 2013 12:25 PM
David Shamansky
US Mortgages - David Shamansky - Highlands Ranch, CO
Creative, Aggressive & 560 FICO - OK, Colorado Mtg

Good post my friend. A lot of info to digest for most but the content is accurate. Hopefully many will read and get a better idea of all that goes into this.



Feb 06, 2013 12:32 PM
Wayne B. Pruner
Oregon First - Tigard, OR
Tigard Oregon Homes for Sale, Realtor, GRI

This post is very informative. I wish I could see the charts.

Mar 28, 2013 02:29 PM