How Interest Rates Come To Be

How Interest Rates Come To Be
How Interest Rates Come To Be

How are interest rates determined?

You have probably been hearing that interest rates are moving up.  What does that mean and why are they moving?

Neither the Federal Reserve nor any branch of government sets mortgage rates and the lender does not arbitrarily come up with them.  Clearly, they are not set by the borrower, so how are they determined?

Rates fluctuate based on simple “supply and demand”.  Mortgage Backed Securities (MBS) are what home loan rates are tied to and they are sold to investors who seek long term, stable income.  The more demand by investors for MBS the lower the yield needs to be to attract them.  If investors are not buying MBS, rates will go up and attract them back in.

Weak economic news often causes investors to move their money out of stocks and into safer investments like bonds. This includes Mortgage Backed Securities.  It is common to see mortgage rates drop when the stock market prices drop and rise when stocks go back up. A good day for your 401k is probably a bad day for your interest rate

Lenders will vary in the rate they offer since they have different overhead costs, profit goals, and access to funds, but typically when demand for MBS drop all lenders will increase the rate they offer.

Make sense?  If not imagine the farmer growing peppers to make hot sauce.  If hot sauce is in high demand the factory will request more peppers and the farmer will have to increase the supply.  If demand drops, the factory orders less and the farmer produces fewer peppers.  Banks don’t grow peppers, but they do make loans and if the demand from investors is high they must lower interest rates to grow more loans.