May
09
How are mortgage interest rates determined?
By
What I mean by that is I assume there is a formula which banks use to figure out what mortgage rates to offer a customer based on prime rates, customers credit history, size of mortgage, etc…
Does anyone know how this process works and the specific formula/methodology used?
thanks in advance!
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3 Comments
May 10th, 2010 at 11:49 am
In general, mortgage rates are determined by the bond market, the 10 yr. treasury to be specific.
Different lenders use different formulas – there isn’t one magical formula that all lenders use. Also, it depends if the lender plans to keep the note or sell it to another investor. If it is sold, the lender has to follow the buyer’s guidelines and doesn’t have as much flexibility with determining interest rates.
The rate depends on the type of loan too. Rates for 1st mortgages are different from 2nd mortgages and equity lines. Again, different lenders use different formulas.
May 11th, 2010 at 5:28 am
You hit a lot of key ones, but there are a few more.
Credit history, prime rate, size of the loan, DEBT-TO-INCOME ratio, Loan-to-value ratio, etc.
No bank would publish this info. It is part of their competitive advantage…
good luck!
May 12th, 2010 at 11:20 pm
Rates are determined by investors in the secondary market.
Most loans are originated for sale to Fannie and Freddie so they rates that anyone can offer depends on what Fannie and Freddie can afford to offer on a program (e.g. 30 year, 15 year, etc.) which in turn is driven by what their investors require for a return/yield on their money.
The link below tells you what Fannies investors are requiring roughly.
Then the Fannie/Freddie have to add a spread to that in order to make any money. The link below would represent a “par” rate based on delivery dates for various Freddie programs:
Then, a lender either has to charge fees or offer a slightly higher rate in order to make any money.
Today, we were offering 6.875% with closing costs of $350 in our market.
Of course this conversation does not address the delievery fees required by the agency programs based on credit scores, loan to value, transaction type and occupancy. These delivery fees will add to the closing costs or increase the rate or both if the delivery fees cannot be covered by increasing the rate.
Home equity and portfolio programs are priced by individual banks and there is no single methodology or formula. If they are lending there own money, they can price there programs how ever they like.
There is a similar secondary market for government programs, Ginniemae, which operates a lot the same as the secondary market created by Fannie and Freddie. The big difference is that these are owner occupied programs and there are not as many delivery fees as with the Fannie and Freddie programs.
I hope I have helped to illuminate the subject without over complicating things.