Now, I do not proclaim to be an interest rate aficionado, but my qualifications are this: In a pre 2008 housing market, I was a mortgage consultant. In my short lived career, I have had to explain to many buyers what interest rates are and why they change. In addition, I gave presentations to first time homebuyers and advised them on the whole process, from application to closing on your first home. With recent news of interest rate changes and fluctuation in both the housing market and mortgage applications, I figured it would be the perfect time to go over my summary of why rates mortgage rates change. There are 2 major factors why your interest rates may change versus someone else. First (and most obvious) is the person applying.
There are many factors that will determine the rate you receive:
- One of the primary factors is your credit profile. Not only a high FICO score, but also in depth and consistency of payments.
- Your job, how long you have been there, and income are obviously a large part in the consideration
- PITI – This is a piece of mortgage jargon that is used to describe how many months of reserve funds a borrower would have in case of job loss etc. It is pronounced pity (ironically) and stands for principal, interest, taxes and insurance. In the best case scenarios, they would like to see at least 6 months worth of reserves.
- Loan amount to value – also referred to as your LTV, this is the amount you will put down for a downpayment. The remainder being the loan the bank will lending. Generally, higher loan amounts with less money down, can result in higher interest rates.
The second reason why you might have a different rate than your neighbor is the Secondary Market. To understand how this market can affect your interest rate, we have to look at your local bank. A bank wants to lend money to candidates who have the highest probability of repaying the full amount borrowed, plus a little something extra. This means that to certain people, the bank will offer a loan to with a competitive rate (these people are commonly referred to as A+ Borrowers). This select group of people have ample savings, a strong established credit and a stable and well paying career. So what happens to the rest of us who don’t have private jets or a trust fund? Well, since the bank doesn’t want to lose business, they will still originate the loan, just apply a higher tiers of mortgage rates then sold in bundles to the secondary market.
The secondary market is something that a lot of new homeowners already know, either consciously or unconsciously. For new home buyers who have received a notice from your local bank that your payments will be made to a different bank, this is the secondary market in action. In essence, your local bank lumps together a groups of borrowers (anywhere from dozens to hundreds of borrowers) who have similar characteristics (as listed above) and then sells those loans to very large banks. This massive system of buying and selling mortgages (also known as mortgage backed securities or BMS) is one of the main reasons why rates will change. According to Bank Rate,”it’s these investors in the secondary market who collectively determine the interest rate of your mortgage loan. Your lender offers you an interest rate that investors on the secondary market are willing to buy” (bankrate.com)
The secondary market is necessary evil. You may prefer to stay at your local bank or credit union, but without this option, many banks would be unwilling to lend to people who don’t fit in the same mold as those top tier borrowers. Not only that, but with the help of supply and demand, “…these investors (large bank who purchase your mortgage) in the secondary market who collectively determine the interest rate of your mortgage loan. Your lender offers you an interest rate that investors on the secondary market are willing to buy” (bankrate.com).
My final word on this is plan ahead. Give yourself time to get your financial picture the best it can. Recently the Federal Reverse published a report that “…When faced with a hypothetical expense of only $400, 59 percent of adults in 2017 say they could easily cover it” (Federal Reserve.gov). So take your time and squirrel away cash to prepare for a down payment. Be well aware of your credit history and think 2 or 3 years ahead of looking at homes. Being prepared could saved you 10’s of thousands of dollars over the life of your mortgage.
I hope you find this blog post helpful. There are a lot of factors that go into getting a mortgage. This post does not cover everything, although I have tried to shed light on some of what is being discussed in the news.
Since buying a home can be challenging endeavor, I have included below some help links for first time homebuyers.
https://www.mass.gov/info-details/the-homebuying-process-in-massachusetts
https://www.mortgagecalculator.org/
Work Cited
https://www.bankrate.com/finance/mortgages/how-lenders-set-rates.aspx
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