- Mortgage rates are determined by a mixture of factors you can't control and ones you can control.
- The stronger the US economy, the higher mortgage rates are across the board.
- Lenders will offer you a lower rate if you have a good credit score or high down payment.
Factors influencing mortgage rates range from those you have some control over — like your credit score — to larger macroeconomic trends or world events that impact the overall cost of borrowing money.
All of these factors play a part in determining how much you'll pay in interest on your monthly mortgage payment. Wondering exactly how mortgage rates are determined? Let's take a look at some of the main elements that can affect how lenders set mortgage rates.
External factors that affect mortgage rates
1. The economy
If you're having trouble understanding mortgage rate fluctuations and where they're coming from, look to the economy.
Mortgage rates tend to be higher when the economy is in a good place and lower when it's in a bad place. Rapid growth and an increase in inflation puts upward pressure on rates, while slow economic activity allows them to fall.
2. Federal funds rate
The federal funds rate is the interest rate banks charge when they lend to each other overnight, and it's set by the Federal Reserve. The Fed's rate affects many other types of consumer rates.
The Fed has an indirect impact on mortgage rates. Mortgage rates don't directly follow this rate, but they often trend up or down in anticipation of Fed rate hikes or cuts. The Fed raises rates to try to cool off an overheated economy and bring inflation back down. This makes borrowing more expensive and slows economic growth. But if the economy needs a boost, the Fed may lower rates to make borrowing cheaper and encourage economic activity.
Personal factors you can control
1. Credit score
Your credit score is a number representing how risky you are as a borrower. A higher credit score indicates you're likely to pay back a loan because you pay bills on time and have a history of borrowing (and paying back) money.
Credit scores range from 300 to 850. Here are how the scores break down, according to the FICO model:
- Poor: 300 - 579
- Fair: 580 - 669
- Good: 670 - 739
- Very good: 740 - 799
- Excellent: 800 - 850
There probably won't be much (or any) difference in your rate if you increase your score from 710 to 720, for example. But a lender will probably give you a better rate if your score goes from fair to good, or good to very good.
2. Debt-to-income ratio
Your debt-to-income ratio is the amount you pay toward debts each month, divided by your gross monthly income. If a large portion of your income is spent on debt, that makes you riskier as a borrower.
The lower your DTI ratio, the better. The minimum DTI ratio depends on the lender and type of mortgage you get, but it typically ranges from 36% to 50%. If your ratio is even lower than the lender's minimum, you could get a better interest rate.
3. Down payment amount
The minimum down payment you'll need depends on which type of mortgage you get. Some loans, like VA or USDA loans, allow 0% down. Conforming loans require a minimum down payment of 3%. Certain lenders might require more than this, depending on the type of loan you're getting.
If you can put down more than the minimum, the lender will probably reward you with a better rate.
For example, maybe a lender's minimum down payment for a conforming loan is 3%. But putting down 10% or 20% can typically help you get a lower interest rate.
4. Type of mortgage
Your interest rate depends on which type of mortgage you get. Here's what you can expect:
- Conforming mortgage: This is what you probably think of as a "regular mortgage." These rates are often higher than government-backed mortgage rates.
- Jumbo mortgage: These are mortgages for amounts above the conforming loan limit. Rates on these loans may be comparable to or higher than conforming rates.
- Government-backed mortgages: FHA, VA, and USDA loans have some of the lowest rates for people who qualify. These mortgages are backed by federal agencies, which will compensate your lender should you default on payments. Government-backed mortgages are the least risky for lenders, so they tend to have the lowest rates.
You also may pay more depending on whether you're getting a mortgage for a primary residence vs. an investment property. The riskier the loan, the more you'll pay.
5. Mortgage term
When you get a mortgage, you'll typically have at least a couple of choices of how long you want the loan term to be. The shorter your mortgage term, the lower your rate should be.
For example, 15-year mortgage rates are lower than 30-year mortgage rates.
Keep in mind that shorter terms result in higher monthly payments because you're paying off the same loan principal in a shorter timeframe. But you will pay a lower rate and save money in the long run. You can use a mortgage calculator to see how a different term length or mortgage rate would impact your monthly payment.
How to get the best mortgage rate
Work on factors you can control
You can't control whether the economy is struggling or flourishing. Of the factors that you can technically control, not all will be within your reach. For example, maybe you aren't willing to get a shorter mortgage term with a lower rate, because the resulting monthly payments would be too high for your budget.
But maybe you can pay down some credit card debt. This would both lower your debt-to-income ratio and probably increase your credit score, both of which would help you land a lower rate.
Shop around for lenders
Each mortgage lender will charge you a different mortgage rate, so comparing quotes from multiple mortgage lenders will help you get the best deal.
If you're still early on in the process, you can call around to see what kinds of rate lenders are offering, or you could get a mortgage preapproval with a few different lenders to get a quote based on your finances and credit. Just keep in mind that when you do this, the lender might do a hard credit check, which shows up on your credit report and could temporarily drop your score.
How are mortgage rates determined FAQs
Mortgage rates are influenced by many different key factors, including inflation, the monetary policy set by the Federal Reserve, and bond market conditions.
A larger down payment reduces the amount you're borrowing relative to the value of the home, keeping your loan-to-value ratio low. Lenders like lower LTV ratios because there's less risk, so those with a large down payment often get better mortgage rates.
Fixed mortgage rates aren't tied to the 10-year Treasury, but they typically track this yield since they attract the same types of investors. Mortgage rates on ARMs, on the other hand, are based on the index they're tied to, like the Secured Overnight Financing Rate (SOFR).
