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What determines mortgage rates?



Many consumers are misinformed about the different factors in the economy that impact mortgage rates.  A common misconception among borrowers and also some members of the media is that the Federal Funds Rate set by the Federal Reserve is tied to mortgage rates.   When the Fed cuts the Fed Funds Rate and mortgage rates don't go down accordingly many people are left scratching their heads wondering why.  

The reason for this is that mortgage rates are determined by Mortgage Backed Securities (MBS) and the current coupon they are trading at.   MBS are traded every business day just like stocks and other bonds.   As investor demand for MBS increases, the price of MBS goes up and the yield goes down resulting in lower mortgage rates.

A simple way to think about mortgage rates is anything that increases investor demand to buy mortgages results in lower mortgage rates.   For example when an investor pulls money out of stocks they usually turn to safer fixed income investments to put their money and MBS is one option they have.  So when stocks decline that is one possible reason demand for MBS could increase.  Another factor that can help investor demand for mortgages is low inflation.  MBS and other bonds are fixed income investments so inflation diminishes the returns on that type of investment.  If inflation is low then the fixed investments remain attractive.   On the other side, if inflation is high then investments like MBS are less attractive and demand decreases causing mortgage interest rates to increase.  

The reason that mortgage rates often increase when the Fed lowers rates is because the lower Fed rate is a stimulus for the economy and often leads to higher inflation in the future.   This is bad for mortgage bonds which is why mortgage rates usually increase when the Fed cuts their rate.  

Another misconception some people have is that mortgage rates are based on the US 10 year Treasury Bond.   Often times the MBS market moves within a certain spread compared to the 10yr but at times there is a large disconnect between the two.   This is the problem we are currently experiencing that is keeping mortgage rates higher than they could be given more traditional spreads.  There are days where the yield on the 10yr will drop while the yield for MBS will increase when normally they would move in a similar path. 

Daily trading prices and yields for Mortgage Backed Securities are not as readily available as information on stocks markets and government bonds.  At HomeQuest Mortgage we subscribe to a service that gives us access to track the daily trading yields of MBS.  This allows us to give our borrowers the most up to the minute advice on whether to lock or float their interest rate depending on current market conditions.  


Difference between mortgage brokers and mortgage lenders



One of the first decisions consumers have to make when deciding which mortgage company to close their mortgage with is if they want to work with a mortgage broker or a mortgage lender.   There is actually little difference between the two once you look at each business structure in detail.

A mortgage lender uses a line of credit to fund the loans in their name.   Once the loan closes the lender immediately sells the loan to a servicing bank and repays their line of credit before the 1st payment is even made on the new mortgage.   When they sell the loan to the bank they get paid a commission based on the rate of the loan and the loan amount.  

A mortgage broker does not fund the loan in their name.  Instead they find a bank that will fund and service the loan.   Like a mortgage lender that sells their loan to the servicing bank, a broker typically gets paid a commission called Yield Spread Premium (YSP) for arranging the loan for the servicing company.  

One difference between a broker and a lender is that the broker has to disclose on the Good Faith Estimate how much the YSP is while the lender does not need to disclose it.

Both a lender and a broker work with the same set of guidelines provided by the loan servicers (banks).   A lender does not have any special authority to fund a loan if it does not fit into the guidelines because they still have to find someone to buy the loan once it closes so that they can pay back their line of credit that is used to fund the loan.     

In most cases the rates that lenders and brokers offer should be similar since neither are creating their rates internally.

So you might be asking then if brokers and lenders get their rates from the same places (mortgage banks) then why do rates sometimes vary so much between different companies?   The reason is that some companies are trying to make more or less YSP than their competitors.   Since part of the YSP is determined by the interest rate on the loan (the higher the rate the more YSP that is paid) some companies will be willing to offer a lower rate and make less commission on the loan than other companies.   Essentially you will get the best combination of rate and closing costs when you find the company that will do your loan for the lowest commission.

At HomeQuest we became a rate leader in the market by offering our borrowers lower rates that pay us less YSP then most companies are willing to do a loan for.  We are set up to do a high volume of loans at lower YSP to make sure that our borrowers are getting the best loan possible.   Other companies will try to do just a handful of loans per month but make much more on each loan by giving their borrowers higher rates and fees.  

We believe that our philosophy works best for us because it gives our borrowers a better loan and in return earns HomeQuest repeat business from our borrower in the future as well as referrals from their friends and family.      

There are some mortgage companies known as portfolio lenders that will originate and service the mortgage.   Rates offered by these banks are normally higher than rates offered by mortgage brokers.   If a mortgage broker has a broker agreement with the mortgage bank often times they can get the borrower lower rates than the borrower would be able to get if they went directly to the same bank.   The reason is the bank has less overhead fees when the loan is brokered to them.   They do not have to pay an internal processor or loan originator on the file or spend any marketing dollars to get the loan.   Instead they just pay the YSP to the mortgage broker which is cheaper than their internal costs would be if they originated the loan themselves.  Therefore they can give the mortgage broker lower rates to offer potential borrowers than they can offer directly to the borrowers themselves.  

Another benefit of working with a broker over a bank is banks are restricted to offer potential borrowers loans within their banks portfolio.   If they don't have what you are looking for you have to go elsewhere to find the loan that is right for you.   A mortgage broker can do this ahead of time by checking different banks guidelines until they find a bank that offers the type of loan and rate you are looking for from the start.

Myths about obtaining a mortgage during the "credit crunch"


Everyday we get calls from worried borrowers asking how difficult it is to get financing given the state of the economy and the lending environment.   Many borrowers are hearing from the media that you need to have excellent credit and a 20% down payment in order to get qualified for a loan now.   This is simply not true.   While it is true that lending guidelines are tighter than they have been the past few years these statements are an exaggeration of the requirements for getting a mortgage. 

If you are purchasing a primary residence or a vacation home you can still make as little as a 5% down payment and get the lowest fixed rates available on the market.     In some cases only a 3% down payment is required, even with today's more strict guidelines.

One area that has been cut back on is income documentation.  In the past borrowers could get a loan without proving to the underwriter how much money they earn or even if they had a job at all.   Now almost every loan program calls for income documentation through personal tax returns for self employed borrowers or a paystub and last years W2 for borrowers who are not self employed.    

For credit scores lenders want to see your mid FICO score at 620 or higher.  If you want the best rates on the market your score will have to be at least 740 in most scenarios.  

The main point is that while mortgages are not as easy to get today as they were last year, financing is still available and banks still have money to lend.   If you have any questions or would like one of our loan officers to review your individual scenario just give us a call!  


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