How are Mortgage Interest Rates Determined?

By Amy Nutt

When purchasing a home, the interest rate on a mortgage will play an important role in how much you will have to pay each month. It is important that one is aware of how these rates are set so that they will be able to get the best rate and a rate that they can afford. Understanding rates can make the difference in saving hundreds or even thousands of dollars each year.

Interest rates directly affect the amount of money that flows into the economy. High interest rates will not only curb inflation, but will also decelerate the economy. Low interest rates will provide a boost to the economy, but can also cause inflation if the rates stay low for too long of a period of time. When it comes to mortgage rate levels, most of the determining factors about mortgage rates come from New Yorks Federal Reserve Bank. When the Federal Reserve adjusts their rate, banks interest rates will also adjust.

Mortgage interest rates are the rates that a lender applies to a mortgage. A mortgage includes the amount of the loan plus the interest rates. Homeowners are responsible for paying these rates as well as the mortgage for the entire term of the loan. Interest rates can be driven by a number of factors. For instance, variable interest rates, or adjustable rates, are controlled by the Federal Reserve. Rates on long term loans are influenced by Treasury Note yields. Treasury notes are auctioned on the open market and the yields react to the demand for the notes.

Key Interest Rates Include:

Fixed Interest Mortgage Rate: This rate is fixed for the entire term of the loan. If a homeowner has a mortgage with an interest rate of 7%, and the market pushes rates up to 10%, the monthly interest rate payment will stay at 7%. If the economy pushes the rate down to 5%, the homeowner will not benefit from a lower interest rate.

Treasury Notes: These interest rates are fixed for the term of the loans. The rate depends on the demand for the Notes at auction.

Federal Funds Rate: The Federal Funds Rate is the rate that banks charge one another for overnight loans of reserve balances.

Variable Interest Mortgage Rate: This rate, set by the Federal Funds, is usually a few points above the bank rate. It varies with the Federal Funds rate and fluctuates with market conditions. You will benefit with good market conditions, but if market conditions turn bad, you may end up paying a high interest rate.

When applying for a mortgage, a lender will look at your credit history and your risk of defaulting on mortgage payments. Maintaining a good credit history and having a secure job will help you obtain a low interest rate. The higher the risk, the higher your interest rate will be. By understanding interest rates, you and your lender will be able to determine which interest rate is best for you. Like most things in life, having knowledge about the basics of mortgages and interest rates is essential to getting the best mortgage deal.

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