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How Are Mortgage Rates Determined


What You Need To Know

  • Your mortgage interest rate is determined daily by lenders based on the overall health of the economy, the type of mortgage you take out and your finances
  • Lenders use different interest rate indexes to determine how much they’ll charge you in interest
  • A 15-year mortgage loan usually comes with a lower interest rate than a 30-year loan


When you started looking for a mortgage, you probably saw different advertised mortgage interest rates and wondered who sets these rates and how they’re calculated. Stab in the dark here, but you probably also wondered what you needed to do to make your mortgage interest rate lower.

Well, your mortgage rate is affected every day by market forces you can’t control, like the overall health of the economy, and factors you can control, like the lender you choose, the size and type of loan you take out, whether you plan to live on the property and your finances.

If you’re interested (see what we did there?) in learning more about mortgage interest rates and how these factors will play a role in determining the mortgage interest rate you qualify for, keep reading.

How the Economy Affects Mortgage Rates

Lenders are affected by all kinds of economic factors and market forces that are beyond their control.

Mortgage-backed security (MBS) market

Mortgage lenders offer mortgages to borrowers – and sell them on the mortgage-backed security market. 

Investors like mortgage-backed securities (aka mortgage bonds) because they’re a relatively safe investment with a low but consistent rate of return.

When the demand for mortgage bonds goes up (usually because stocks are down), mortgage rates increase. When the demand is low (because the stock market is doing well), mortgage rates drop. 

U.S. Treasury bond market

Historically, Treasury bonds are considered a “safe” place for people to park their money in an uncertain economy. That makes the bond market a useful measure of long-term economic health. When more people are buying Treasury bonds, it may signal a drop in interest rates.

Unemployment rate

When people are working, they have more money to spend and interest rates tend to go up. When unemployment is high, interest rates tend to go down to encourage more spending.

Inflation rate

Inflation measures how much stuff a dollar can buy. When inflation is high and prices go up, interest rates tend to go up as well. The theory is that, by reducing the money supply, goods and services become less affordable. When goods and services are less affordable, fewer people want to buy them. That reduces demand and stabilizes rising prices.

Local and national housing markets

When interest rates are low, people are more likely to buy a house. This can lead to higher demand, which would make the housing market more competitive.

How Do Lenders Measure the Health of the Economy?

Because the economy is complex and moves fast, lenders use different resources to help them make informed decisions when they’re setting interest rates. Lenders usually look at one or more of these economic indicators:

Federal funds rate

The Fed’s biggest role is to fight inflation (high prices), encourage spending and employment and keep the U.S. economy stable. The Fed does this by controlling the federal funds rate. Lenders pay this interest rate to borrow money from the government and each other. It essentially sets a minimum floor for interest rates.

If the Fed raises or lowers the federal funds rate, lenders adjust their interest rates to keep up. 

Secured Overnight Financing Rate (SOFR) 

The SOFR is an interest rate index that’s run by the Federal Reserve Bank of New York in cooperation with the Office of Financial Research in the U.S. Treasury Department. 

The SOFR is set based on the cost of day-to-day borrowing for banks. It’s used by lenders to determine a mortgage’s base interest rate (based on the type of mortgage). It’s become the new industry standard and is set to replace the London Interbank Offered Rate (LIBOR).

Constant maturity Treasury (CMT) rates

This is another index lenders use to set interest rates. The CMT takes the average return for different types of Treasury securities that mature (think: reach full payoff value) over different lengths of time and uses it to extrapolate the future value of Treasury securities. 

Essentially, it’s a way for lenders to try to predict what’s coming up based on past performance. 

How Mortgage Type Affects Mortgage Rates

Here’s something you do have control over: the type of mortgage you pick. Assuming that the economy is on your side, the type of mortgage you apply for will affect the mortgage rate you’re offered.

Conventional or government-backed mortgage

The majority of mortgage loans in the U.S. are conventional mortgage loans.[1] That means that the lenders set loan terms at their discretion.

If you’re interested in a government-backed mortgage, the lender has the final say in setting the interest rate, but the U.S. government has a say, too.

  • Federal Housing Administration (FHA) loans: Anyone can apply for an FHA loan. The loans are targeted to home buyers with lower credit scores (we’ll touch on that soon) and past debt and credit issues. If you get an FHA loan, you should probably expect to pay a higher interest rate.
  • Department of Veterans Affairs (VA) and U.S. Department of Agriculture (USDA) loans: If you qualify for a VA loan (reserved for veterans, active duty service members and qualified surviving spouses) or a USDA loan (aimed at home buyers interested in buying or building a home in a rural community), you may get a lower interest rate than you would with a conventional loan.

Fixed-rate or adjustable-rate mortgage

The interest rate on a fixed-rate mortgage is locked in for the life of the loan. Adjustable-rate mortgages start with a lower interest rate introductory period usually ranging between 3 – 10 years.

The lower introductory rate is tempting, but it can adjust up or down based on the current interest rate. These adjustments typically happen every 6 months or a year. Depending on the interest rate caps set by your loan terms, your interest rate could rise significantly above the introductory rate.

Mortgage length

Lenders usually charge a lower interest rate for a 15-year mortgage than they do for a 30-year mortgage. Why? With a shorter mortgage, the lender knows the loan will be repaid sooner. 

Yes, you’ll have a higher monthly mortgage payment with a 15-year mortgage, but you’ll pay off your mortgage faster and pay less in interest than you would with a 30-year mortgage. 

Primary residence, vacation home or investment property

Lenders tend to offer lower interest rates for primary residence mortgages than they do for mortgages on second homes or investment properties. Why? Because they know that if things go wrong, a borrower will likely prioritize the mortgage payments on their home over their investment property.

How You Can Control Your Mortgage Rate

Lenders determine the interest rate they’ll charge you based on how much competition there is for your business and your creditworthiness (think: reliability to pay back a loan). The good news is that there are ways to control how these factors will affect your mortgage rate.

Shop for the right lender

While lenders usually adjust their rates based on the Fed, not every lender charges the same interest rate. 

  • Commercial banks: These are the most common types of banks you’ll see. Their size means they can offer a lot in the way of convenience.
  • Community banks: Community banks are also commercial banks, but they are smaller and more tied to the local economy. Community banks tend to be more in tune with the needs of their local community and can offer competitive rates.
  • Credit unions: These banks are nonprofit organizations, which means they can offer competitive rates. Some credit unions are available to anyone in the area, while others are limited to a certain group, such as labor union members or employees who work for a specific employer.
  • Online lenders: Some lenders do everything online. They may be able to offer lower rates because they don’t have to cover the cost of brick-and-mortar branches.

Shopping around for lenders can make a big difference in your interest rate. And if you’re not sure where to start, a mortgage broker can help you compare and identify lenders.

When you’re looking at loan offers, make sure you look at the annual percentage rate (APR) and your Loan Estimate form. The APR and the Loan Estimate can give you the information you need to perform a “true” side-by-side comparison of the real costs of your loan.

Improve your credit score

Your credit score is a number that ranges from 300 – 850 and is a measure of your creditworthiness. Most conventional loans require a credit score of 620 or higher to qualify for a mortgage. The higher your score, the less a lender is likely to charge you in interest.

Creating a budget and paying down debt, especially high-interest credit card debt, is a great way to boost your credit score.

Lower your debt-to-income (DTI) ratio

Your debt-to-income ratio measures your fixed monthly expenses (think: rent, mortgage, minimum credit card payments, student loans, auto loans and personal loans) against your gross monthly income. 

While you can qualify for a mortgage with a DTI of 45%, most lenders prefer 36% or lower. The lower your DTI, the better interest rate your lender can offer you.

Paying off debt or consolidating your higher-interest debt to lower your monthly payment can help improve your DTI.

Increase your down payment

The good news is that it’s easier to qualify for a mortgage loan with a down payment as low as 3%. However, the lower your down payment, the more you’re likely to be charged in interest.

If you need help saving for a down payment, consider asking friends and family for help or research down payment assistance programs in your area.

Approximate Your Mortgage Interest Rate Today

Your mortgage rate will never be entirely in your control, but understanding how your interest rate is calculated can give you the power to control some aspects of your interest rate. 

Want to figure out what your mortgage interest rate will be before you talk to a lender? Many lenders post current mortgage interest rates for different loan types every day. Just remember, the advertised rate will adjust up or down depending on your credit score, DTI and down payment.

You can also use a mortgage calculator to test-drive different interest rates and see how an interest rate will affect your ability to afford a home.

  1. Federal Housing Finance Agency. “NATIONAL MORTGAGE DATABASE (NMDB) AGGREGATE DATA.” Retrieved January 2022 from


In Case You Missed It

  1. The Secured Overnight Finance Rate (SOFR) index is becoming the gold standard for lenders when determining mortgage interest rates

  2. Consider shopping different types of lenders when you’re looking for a mortgage

  3. If you qualify, you can get lower interest rates with a VA or USDA loan than you would with a conventional loan

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