What Is a Mortgage Rate?
A mortgage rate is the percentage of interest that is charged for a home loan.
Broadly speaking, mortgage rates change with the economic conditions that prevail at any given time. However, the mortgage rate that a homebuyer is offered is determined by the lender and depends on the individual's credit history and financial circ*mstances, among other factors.
The consumer decides whether to apply for a variable mortgage rate or a fixed rate. A variable rate will go up or down with the fluctuations of national borrowing costs, and alters the individual's monthly payment for better or worse. A fixed-rate mortgage remains the same for the life of the mortgage.
Key Takeaways
- A mortgage rate is the interest rate charged for a home loan.
- Mortgage rates can either be fixed at a specific interest rate, or variable, fluctuating with a benchmark interest rate.
- Potential homebuyers can keep an eye on trends in mortgage rates by watching the prime rate and the 10-year Treasury bond yield.
Understanding Mortgage Rates
The prevailing mortgage rate is a primary consideration for homebuyers seeking to purchase a home using a loan. The rate a homebuyer gets has a substantial impact on the amount of the monthly payment that they will pay.
Mortgage rates are highly sensitive to economic conditions. Since 1980, average mortgage rates for a 30-year fixed-rate mortgage have hit a high of 18.3%, during a period of runaway inflation in 1981, and a low of 2.6% in 2020, in the early days of the COVID-19 pandemic. In mid-July 2023, the average national rate was 7.2%.
How much does the interest rate matter? Say you want to buy a house that costs $436,000. That's the nationwide average price as of mid-July 2023. You put $87,200, or 20%, down. You need to finance $348,800. A mortgage calculator makes this easy.
Your monthly payment on a 30-year mortgage would be:
- $1,749 at the historic low 2.6% interest rate
- $2,720 at the mid-2023 average 7.2% interest rate
- $5,695 at the historic high 18.2% interest rate
Keep an Eye on the Fed
The biggest single factor that determines mortgage rates and all other borrowing rates in the U.S. is the Federal Reserve's decision on the rates it charges banks in order to maintain the stability of the system. All other loan rates are based on these rates, which are set at meetings held every six weeks.
Mortgage Rate Indicators to Keep an Eye On
Given the impact of interest rates on monthly living costs, people who are considering buying a home are wise to keep an eye on the direction of these rates.
There are a few indicators to follow. The prime rate is one indicator. This rate represents the lowest average rate banks are offering for credit. Banks use the prime rate for interbank lending and may also offer prime rates to their most creditworthy borrowers.
The prime rate tends to follow trends in the Federal Reserve’s federal funds rate. It is usually about 3% higher than the current federal funds rate.
Another indicator for borrowers is the 10-year Treasury bond yield. This yield helps to show market trends in interest rates. If the bond yield rises, mortgage rates typically rise as well. The inverse is the same; if the bond yield drops, mortgage rates will usually also drop.
Even though most mortgages are calculated based on a 30-year timeframe, many mortgages are either paid off or refinanced for a new rate within 10 years. Therefore, the 10-year Treasury bond yield can be an excellent standard to judge.
And, of course, you can keep an eye on the trends in mortgage rates. Freddie Mac updates mortgage rate changes on its site weekly.
Determining a Mortgage Rate
A lender assumes a level of risk when it issues a mortgage, for there is always the possibility a customer may default on the loan.
There are a number of factors that go into determining an individual's mortgage rate, and the higher the risk, the higher the rate. A high rate ensures the lender recoups the initial loan amount at a faster rate in case the borrower defaults, protecting the lender's financial investment.
The borrower's credit score is a key component in assessing the rate charged on a mortgage and the size of the mortgage loan a borrower can obtain. A higher credit score indicates the borrower has a good financial history and is more likely to repay debts. This allows the lender to lower the mortgage rate because the risk of default is deemed to be lower.
Is a Fixed-Rate Mortgage or a Variable Rate Mortgage Better?
A fixed-rate mortgage gives you security. Your payment will never go up, no matter what happens to interest rates in the world outside. If rates go down, you can refinance.
A variable-rate mortgage usually has a slightly lower interest rate to start, keeping your costs low at a time when you might be squeezed for cash. That's because the bank is betting that interest rates will go up, while you're betting they'll go down.
If you lose that bet, your monthly payment will go up, and you won't have the option of refinancing until they go down again.
The Bottom Line
A mortgage rate is the interest that a home buyer will pay to finance the purchase.
You'll get the best rate available if you have a very good credit rating and a financial history that proves you can afford to repay the loan.
However, the range of mortgage rates that are available at any given time is well outside your control. Prevailing interest rates determine mortgage rates, and they change from week to week depending on economic conditions.
