Explanation of Mortgage Rates

Mortgage rates are an important consideration when buying a new home.

Mortgage rates are an important consideration when buying a new home.

One day you’re hearing mortgage rates are up and you should wait on that dream home and then the very next week you hear they’re down and you better act fast. So what are mortgage rates? Well, they’re an important factor in your mortgage loan and a solid explanation will provide you with a better understanding of mortgage rates.

The Basics

Obviously without interest rates, creditors would not exist. Nobody, including your mortgage lender, is going to loan you money without the possibility of making a profit on the loan, which is where mortgage rates come in. So, how are mortgage rates established? The Federal Reserve in conjunction with the Federal Open Market Committee (FOMC) is responsible for governing three factors of monetary policy: open market operations, discount rates and reserve requirements. Open market operations, largely controlled by the FOMC, include transactions pertaining to U.S. Treasury bills and government securities. The discount rate is the interest charged to banks for loans from their regional Federal Reserve lending facility. Reserve requirements are funds that banks must hold to guard against deposit liabilities. These three factors directly affect the interest rates that banks charge for use of federal funds, otherwise known as federal fund rates. Changes to federal fund rates affect a range of economic variables, including mortgage rates.

Highs and Lows

The Federal Reserve is responsible for managing the economy and protecting it against inflation and recession. To guard against inflation, the Federal Reserve will increase rates to slow spending. Alternatively, during a recession, rates will drop with the hope that consumers will be motivated by lower interest rates to spend money and take out loans.

Fixed vs. Adjustable

While there are many types of mortgages, there are basically two types of mortgage interest rates: fixed and adjustable. When you agree to pay a fixed interest rate, you will pay the same interest rate for the term of the loan, regardless of how interest rates fluctuate over the course of your loan. Adjustable rate mortgages are usually set at a lower interest rate for an introductory period of the loan with the expectation that it will then fluctuate during the term of the loan.

Credit Score Impact

Mortgage rates can also be affected by your credit score--you know, that three digit score reflecting your ability to manage your money and pay your bills on time. The higher your credit score is, the lower your interest rate will be. Lower credit scores usually indicate you might be a riskier candidate for a loan so you may have to pay a higher interest rate for your mortgage.


About the Author

Based in South Florida, Leann Harms has been writing since 2008. Her design, technology, business and entertainment articles have appeared in "Design Trade" magazine and Web sites including eHow. Harms has a Bachelor of Arts in English from Florida Atlantic University.

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