How Are Mortgage Interest Rates Really Determined? A Comprehensive Look At Mortgage Interest Rates in 2022

The interest rate plays a crucial role when shopping for a mortgage to buy your dream home. A high-interest rate will make it difficult to afford even if you get approved for a mortgage loan while a low-interest rate means affordable monthly repayments. If you wonder how mortgage interest rates are determined, and what you can do to get a low rate, you have come to the right place. This article provides a comprehensive guide on how mortgage interest rates are determined.

mortgage interest rates

An Overview Of How Mortgage Interest Rates Are Determined

Even though there are several factors that go into determining mortgage interest rates today, you have control only over one factor: the personal factor. In fact, a lender will always look at your qualifying factors to determine your risk level. The better your qualifying factors, the lower the interest rate they’ll offer you. It all starts with the current market rates. You might be wondering how the market affects your interest rate. In fact, mortgage interest rates are affected by the overall economy in the country. 

Rates tend to increase when the overall economic outlook in the country is good. Likewise, rates tend to decrease when the economy isn’t looking great. Even though it seems somewhat backward, there is a reason for it. For example, when the economy is good, borrowers are able to afford more. Without increased interest rates, the demand for mortgage loans can overpower the supply capacity of the lenders. Hence, a slightly increased interest rate will keep everyone on the same level. On the other hand, when the economy isn’t that good, interest rates decrease to make mortgages more affordable to borrowers.

Frequency Of Interest Rate Changes

Interest rates can change many times during the day. The banks receive rate sheets almost every day. If you have a certain interest rate in mind, you should talk to the lender and lock the rate quickly before it changes. 

15-Year Vs. 30-Year Mortgage Interest Rates

If a borrower is able to afford a 15-year mortgage with its higher repayment, he or she will get a lower interest rate. The reason is it costs the lenders more money to lend for 30 years compared to 15 years. If the lender is able to receive his money back in half the time, he will reward the borrower with a lower interest rate.

Which Market Factors Affect Mortgage Rates?

Market factors drive mortgage rates up and down. In fact, the bond market, Federal Reserve, inflation, Constant Maturity Treasury, Secured Overnight Finance Rates, as well as the health of the overall economy of the country, affect mortgage rates.

Federal Reserve

Although you may think that the Federal Reserve or Fed sets mortgage rates, they actually don’t. But the Federal Reserve affects mortgage rates. The Federal Reserve controls short-term interest rates by either increasing or decreasing them depending on the state of the economy. The Federal Reserve rates are not directly tied to the mortgage interest rate. But when Fed rates change, the mortgage rate follows suit.

The Fed controls short-term mortgage interest rates to control money supply in the country. When the economy is on a declining trend – as during the COVID-19 pandemic – the Fed lowers rates. You may have heard about Fed rates closer to 0% during the pandemic season. These are not the rates that are given to consumers, but the rates at which lenders can borrow money to lend to consumers. When it is time to tighten up the money supply, the Fed will increase the rate. The move may not directly increase mortgage rates, but banks should follow suit to bear the costs of borrowing money from the Fed to lend to their consumers. 

Bond Market

Mortgage interest rates are usually tied to the 10-year Treasury Note when they are tied to the bond market. In fact, mortgage bonds or mortgage-backed securities are bundles of mortgages sold in the bond market. Bonds will affect mortgage interest rates depending on their demand. When the stock market is performing poorly, the demand for mortgage bonds becomes high. Mortgage rates increase during such times. On the other hand, when the demand is low, mortgage rates decline.

Secured Overnight Finance Rate

SOFR or Secured Overnight Finance Rate is an interest rate that’s set based on the cost of overnight borrowing for lenders and banks. The SOFR is mostly used by banks and other lenders to determine a mortgage-based interest rate depending on the type of mortgage loan. The SOFR has become popular and serves as the replacement for the LIBOR or London Interbank Offer Rate, which was phased out at the end of 2021.

Constant Maturity Treasury Rates

CMT rates or Constant Maturity Treasury Rates are a yield that is calculated by taking the average yield of different kinds of Treasury securities with different maturity periods. This average yield is then used to adjust for a number of time periods. Some banks and lenders use this rate to determine the interest for ARMs or adjustable-rate mortgages. When the CMT goes up, you should expect an increase in the interest rates in any loans tied to it.

The Overall Health Of The Economy

Mortgage interest rates can increase or decrease based on how the economy is doing today and its overall outlook. When unemployment rates are low and spending is high, the economy is usually doing well. The interest rates will increase in such times. On the other hand, when the economy is not doing well like during the pandemic season, mortgage interest rates will drop.


Inflation and mortgage rates go hand in hand. When inflation is on the rise, interest rates will also increase to keep up with the value of the dollar. Conversely, interest rates drop when inflation decreases. During low inflation times, mortgage rates tend to stay the same or fluctuate slightly.

What Are The Personal Factors That Affect Mortgage Rates?

Apart from economic factors, there are many personal factors that may affect the par rate a lender will offer you. They have interest rates designed for the “best borrowers” as well as “risky borrowers.” Since you have direct control over your personal factors, you can indirectly affect your interest rate. Here are some steps to follow to get the best mortgage interest rate when purchasing your dream home:

Credit Score

A high credit score means less of a risk to banks or lenders. You should not overextend your credit and pay all the bills on time. When a lender pulls your credit, they will see you as a responsible borrower with a very low risk of default. You will get a better interest rate – one that is closer to the advertised rate – since they don’t have to adjust for a low credit score. On the other hand, if you have a low credit score, the lender will have to change the interest rate due to the high risk of default.

What Credit Score Do You Need?

It may usually depend on the loan program. You need at least a 620 credit score for a conventional loan that isn’t backed by the government. On the other hand, if you opt for FHA financing, you will need a 580+ credit score. Here are some steps that you can take to improve your credit and place you in a better position to get a lower interest rate from the lender:

Down Payment

Lenders prefer borrowers who are invested in their homes through down payment and not borrowing 100% of the funds. The more money you have invested in the property, the less likely you are to default. If your down payment is less than 20% of the property value, your interest rate will increase. You will also need to pay mortgage insurance when purchasing the property. There are many types of mortgage insurance depending on the loan program: some plans are cancellable while some are not. You will be at a higher risk of default with a low down payment, and the lender will make up for the risk by increasing your interest rate.

Loan-To-Value Ratio

Lenders will also compare your down payment to the loan amount, which is known as the LTV or loan-to-value ratio. Your LTV becomes higher with less money as a down payment, which becomes a higher risk for the bank or lender. When you have invested less money on your property, you have less incentive to keep paying the mortgage when times get tough. On the other hand, if you have invited more money into the house, you are more likely to go on paying the mortgage even when times get tough.

Banks will charge a higher interest rate when the risk of default increases. For example, if you make a 3% down payment on a $200,000 mortgage, your share is just $6,000. But if you put 20% as the down payment on a $200,000 loan, your share becomes $40,000. In fact, there is a huge difference between $6,000 and $40,000. Banks will offer the borrower with a higher down payment a lower interest rate.


Banks care about whether you plan to occupy the home you purchase or whether it is your primary home. In fact, banks offer lower interest rates for primary homes compared to second homes and investment properties. You are more likely to make your payments on time for a primary home because you don’t want to lose it. When you have a second home or an investment property, you are more likely to default on the mortgage when times become tough. Lenders will charge a higher interest rate to make up for the risk.

How To Estimate My Mortgage Rate?

You can easily estimate your mortgage rate using an online mortgage calculator. Here is the information you need:

. Estimated house price

. Loan term

. Down payment

. Interest rate

. Property tax and home insurance amounts

. Zipcode

You can check today’s interest rates and see where you fall. Getting preapproved for a mortgage loan is the best way to see what type of loan you will qualify for. But if you have an idea of your credit score and loan-to-value ratio or LTV, you can easily estimate the interest rates using today’s rates.

Bottom Line

Your mortgage rate will influence the overall monthly payment. Personal and market factors will affect your mortgage rate. You can easily control your personal factors by improving your credit score and saving for a larger down payment. The personal factors will determine your interest rate when buying your dream home. To know how much mortgage you can afford, check out our online mortgage calculator.