So who or what determines the interest rates for mortgages?

We all like to blame the lender for the rates, especially when the rates rise. Did you know that the lender has very little to do with the rate? Your lender may have control over the rate they charge you by about ¼%... especially with this competitive marketplace battling for your loan.

In reality, the lender has very little to do with the rates on the grand scale of things. There is no “Great OZ” behind a curtain trying to figure out how to swindle you out of your hard-earned money. Even the big boys like Citi and Wells or WAMU answer to the higher power for mortgage rates… that being the secondary market.

The secondary market is where FNMA (Fannie Mae) and FHLMC (Freddie Mac) is where these and other mortgage investors practice their trade. These huge agencies; originally founded with the help of the government to make the mortgage lending process more efficient; purchase loans that lenders make and then hold them in their portfolio or bundle them up into mortgage backed securities.

Those securities get sold to mutual funds, Wall Street firms and other financial investors who trade them the same way they trade treasury securities and other security instruments like bonds.

As a result of this business model, the investors rather than the bankers or mortgage brokers, are in control when it comes to setting mortgage rates. Whenever economic news shows the economy is heating-up too much, these investors demand higher yields from the mortgage lenders.

Why? Because the investors don’t want to buy low-yield bonds in a heated economy where the Fed will hike up the rates to slow down the economy and possible inflation. If the Fed raises rates it make higher-yield bonds available and the mortgage securities; if their rates (yields) are too low, are not competitive as an investment vehicle. Like any product, price (rates) is set by the competition for your same product. If the investor can get a better price, they will put their money there. The mortgage=backed security has to adjust their price (rate) up to compete with the other investment vehicles being offered.

The same thing is true when the economy is slowing. These investors start battling for bonds because they figure the Fed will lower rates to stimulate the economy and if they wait, they will end up with lower yield bonds. Since the investor demand is strong, the lenders who control loan supplies can offer lower yields. This results in lower rates for the consumers.

What is very interesting too, is that a lower-yield (rate) bond can actually be more valuable than one that is at a higher rate. Higher rate bonds (loans) tend to be paid off quicker and thus don’t last as long as an investment. A lower rate bond (like your mortgage) will not likely be paid off as soon as a higher rate loan. Most consumers think that the banks (investments) want the higher rates when in fact the lower rate loans are more valuable to the secondary market because they will stay on the books longer.

So what can you do? The actual mortgage banker or broker has little to do with where the rates are going. They are being told what is available by the secondary markets (Wall Street). You need to pay closer attention to the financial news than ever before. If the economy is on the rise, rates are going up as well as a means to keep the economic growth modest and thus inflation at bay. If the economy is slowing and the news is telling you that we are in for a slow-down, the rates will also drop, as the Fed is lowering rates to reduce the cost of borrowing resulting in a stimulus.