How Are Mortgage Rates Determined?

Written by Samantha CatheyUpdated: 28th Dec 2021
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Interest rates in the U.S. can seem arbitrary. Among a lot of financial concepts, they can be difficult to understand to the average consumer.

From car loans to mortgagesto personal loans, rates change daily, and everyone qualifies for something different. So, where do these numbers come from?

Understanding How Mortgage Rates Are Determined

Mortgage rates are controlled by a combination of market factors and personal factors. Therefore, some are in your control while others are not.

Generally speaking, the strength of the U.S. economy sets the tone for mortgage rates, and from there, individual characteristics like credit score and employment narrow down exactly what you’ll be offered.

>> More: Compare the Best Mortgage Lenders

What Market Factors Affect Mortgage Rates?

Market factors are out of your control and affect literally everybody. Government monetary policy and economic issues impact how mortgage rates are set in the U.S. Here are some specific examples.

The Federal Reserve

The Federal Reserve, often just called the Fed, has many duties you can read about here. One of them is maintaining inflation by controlling the money supply between banks through the federal funds rate, which is the rate financial institutions use to borrow money from each other overnight.

So, while the Federal Reserve doesn’t set mortgage rates, it does influence them by moving the ­­­­federal funds rate target in response to movements in the economy. The Fed rate and interest rates move in the same direction.

Additionally, the Fed has been investing in mortgage bonds since the 2008 financial crisis, keeping mortgage rates low as a result.

During the coronavirus pandemic, the Fed has continued to purchase billions worth of mortgage bonds, and it has kept its federal funds rate target between 0 and .25 percent.

>> More: How the Federal Reserve Affects Mortgage Rates

Bond Market

It’s helpful to think of a mortgage as a financial instrument not unlike commodities, derivatives, stock shares, and bonds.

In fact, mortgages with similar characteristics are lumped together to form mortgage bonds or mortgage-backed securities (MBS).

These bonds are then sold to an investment bank or a government-sponsored enterprise, usually Fannie Mae and Freddie Mac, for investment on the secondary market. These entities are trading home loans essentially.

This is called the bond market, which is a safer place to keep your money than the stock market.

They might seem a little strange, but mortgage bonds are a very safe asset. When investors buy mortgage bonds, interest rates tend to decrease because the underlying rate (of the actual mortgages) doesn’t need to be as high to attract investors.

Conversely, interest rates tend to rise to attract investors to purchase bonds if money is shifting away from the bond market.

Homeowners don’t want high-interest rates, but mortgage investors in mortgage-backed securities do.

>> More: How Do Bonds Affect Mortgage Rates? 


Inflation measures the general increase in the cost of goods and services in our economy. It can occur when production costs rise or a sudden surge of demand for services and products.

If inflation is rising, that means the dollar is losing buying power. Therefore, when inflation is going up, so are interest rates because lenders need to compensate.

The most popular type of home loan, the 30-year fixed-rate mortgage, has maintained a rate below 5 percent for most of the past decade, mirroring years of low inflation.

The Fed tries to keep inflation at about 2 percent through contractionary or expansionary monetary policy, but lately, it’s been hovering at about 5.25 percent.

  • Remember: low inflation = low rates.

>> More: What Is a Fixed-Rate Mortgage?

Job Growth

The country’s official unemployment rate is released every month by the Bureau of Labor Statistics. This number and the report it’s found in hints at the economy’s strength or weakness.

If more people are jobless, the Fed lowers interest rates to encourage borrowing and make it more affordable for people to take out loans.

Overall Economy

Mortgage rate fluctuations are congruent with the overall economy. When the economy is growing, accompanied by high inflation and a low unemployment rate, rates are growing, too.

But when the overall economy is slowing, characterized by falling inflation and an uptick in unemployment, rates are slowing, too.

The logic is that when the economy is doing well, homeowners can afford higher payments. If mortgage rates do not increase, the demand will exceed lenders’ abilities to accommodate home loans.

What Personal Factors Affect Mortgage Rates?

Lenders examine your qualifications to determine your risk level, which in turn helps them decide what rate they will offer you.

Boost your odds of approval and securing a low-interest rate by improving your credit score and saving as much as possible for a down payment.

Credit Score

Borrowers with FICO credit scores of 740 or higher are offered the lowest mortgage rates because they pose a much lower risk of defaulting. In contrast, as someone’s credit score decreases, they are considered a riskier borrower, so their interest rates increase.

When individuals have scores below 620, their conventional mortgage rates skyrocket (if they even qualify), so it’s best for them to apply for a government-backed home loan such as those offered by the FHA, USDA, or VA.

Loan-to-Value Ratio & Down Payment

Lenders consider the size of your down payment when determining your interest rate. Borrowers with smaller down payments are considered riskier than those with sizable ones, and banks compensate by charging a higher interest rate.

The loan-to-value ratio measures the financed loan amount compared to the home’s value or price. For example, you put $50,000 down on a $250,000 house which is 20 percent of the home’s price.

Therefore, the financed loan will be $200,000, which is 80 percent of the home’s price, giving you a loan-to-value ratio of 80 percent.

A percentage greater than our example is considered too high and may result in a higher interest rate.

Additionally, mortgage insurance will be required if more than 80 percent of a home needs to be financed (aka less than 20 percent was put down).

  • The larger the down payment, the smaller the LTV ratio.
  • The smaller the down payment, the larger the LTV ratio.

>> More: Mortgage LTV vs. CLTV

Property Type

It may come as a surprise, but the type of property you’re trying to finance can influence your interest rate.

Single-family, primary residences get the cheapest financing. Certain manufactured homes, condominiums, and multi-unit properties are subject to surcharges, and investment properties carry higher risk and interest rates.

Unique dwellings like high-rises, ranches, domes, and co-ops also carry higher rates.


Lenders examine applicant’s employment history to help determine if they will have a steady income in the future. Make no mistake, your employment matters when buying a house

After all, that is how the bank will get paid. Longer gainful employment reflects better than gaps in someone’s job history.

How to Estimate Your Mortgage Rate

The best way to estimate your mortgage rate is to get pre-approval from multiple online mortgage lenders, but you can estimate your payments.

Online loan calculators are a great tool to consult when you’re preparing to take out a loan of any kind. With mortgage calculators specifically, you can input the following pieces of information to estimate your payment:

  • Down payment amount
  • Estimated home price
  • Interest rate
  • Loan term
  • ZIP code
  • Property tax and home insurance

Most calculators auto-generate the current average interest rate and provide median homeowner’s insurance and property tax information for their area.

Frequently Asked Questions

Are rates the same for all lenders?

Different overhead costs and propensity for risk determine what rate a bank or credit union will offer you. Typically, rates are within a few percentage points of each other, but it’s important to be aware of closing costs which can be dramatically different between lenders. A super low rate may be hiding higher closing costs. Finally, banks might charge lower rates to stir up business or raise their rates if they are at capacity.

Do Mortgage Rates Depend on Income?

Since rates are partially based on your credit score and down payment, it’s a safe bet that if you bring home more income than your neighbor, you’ll be able to pay down debt and accumulate a nest egg. Lenders also consider your debt-to-income ratio, or how much of your gross monthly income is paying off debt.

Do Mortgage Rates Change Every Day?

Mortgage rates can change daily, even multiple times a day, depending on the prices and yields of mortgage-backed securities. Your window for rate shopping before it must be locked in is short enough that interest rates shouldn’t rise or fall very much overall.

Who Sets Mortgage Rates?

Banks, credit unions, and private mortgage lenders base their rates on national benchmarks, like the federal funds rate, and each other to stay competitive.

Does the Federal Reserve Control Mortgage Rates?

The Federal Reserve does not control mortgage rates, but it does control short-term federal interest rates, and when those change, mortgage rates slowly follow.

Bottom Line: How Mortgage Rates Are Determined

Lenders offer different rates to different customers, but the Equal Credit Opportunity Act “prohibits credit discrimination on the basis of race, color, religion, national origin, sex, marital status, and age.” Additionally, this act helps curtail redlining.

Still, sometimes people are discriminated against, which just further supports the notion of getting pre-approval from multiple lenders. Each bank has its own standards and its own mortgage rate.

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Samantha Cathey
Samantha Cathey

Samantha Cathey is a Senior Personal Finance Writer & Product Analyst with years of financial training and industry knowledge. She is a former banker, loan officer and investment advisor before dedicating her energy to helping individuals more creatively, through her writing. Samantha studied at the University of Idaho where she majored in Journalism and Writing. Her areas of expertise are mortgages, credit cards, loans, and investing.