How Are Mortgage Rates Determined?

What factors determine mortgage rates?

Your mortgage rate is determined by many factors. Some are within your control and some aren't. With awareness of these factors, you can feel more confident about getting a competitive interest rate when you choose a mortgage lender.

Mortgage rate factors that you control

Lenders adjust mortgage rates depending on how risky they judge the loan to be. A riskier loan has a higher interest rate.

When judging risk, the lender considers how likely you are to fall behind on payments (or stop making payments altogether), and how much money the lender could lose if the loan goes bad. The major factors are credit score and loan-to-value ratio.

Credit score

The lowest mortgage rates go to borrowers with credit scores of 740 or higher. These borrowers have the broadest choice of loan products.

Interest rates tend to be a little higher for borrowers with credit scores of 700 to 739. For borrowers with credit scores from 620 to 699, mortgage rates are even higher. These borrowers might find it difficult or impossible to get high-amount jumbo loans.

With a credit score below 620, the interest rates are even higher, and options are fewer. Most of the loans available at this level are insured or guaranteed by the government.

» MORE: The credit score needed to buy a house

Loan-to-value ratio

The loan-to-value ratio measures the mortgage amount compared with the home's price or value. Let's say you make a $20,000 down payment on a $100,000 house. The mortgage will be $80,000. You're borrowing 80% of the home's value, so your loan-to-value ratio is 80%.

A bigger down payment gives you a smaller loan-to-value ratio, and a smaller down payment gives you a bigger loan-to-value ratio.

If your loan-to-value ratio is greater than 80%, it's considered high, and it puts the lender at greater risk. This may result in a higher mortgage rate, especially when combined with a lower credit score. The loan will usually require mortgage insurance, too.

» MORE: Loan-to-value calculator and definition

Other factors

Lenders may charge more for cash-out refinances, adjustable-rate mortgages and loans on manufactured homes, condominiums, second homes and investment properties because those loans are deemed riskier.

» MORE: How to get the best mortgage rate

Mortgage rate factors beyond your control

The overall level of mortgage rates is set by market forces. Mortgage rates move up and down daily, based on the current and expected rates of inflation, unemployment and other economic indicators.

Overall economy

Mortgage rates tend to rise when the outlook is for fast economic growth, higher inflation and a low unemployment rate. Mortgage rates tend to fall when the economy is slowing down, inflation is falling and the unemployment rate is rising.

Inflation

Interest rates tend to move in the same direction as inflation. Rising inflation is often accompanied by climbing interest rates, and declining inflation is often accompanied by falling interest rates.

The inflation rate skyrocketed from early 2021 to the middle of 2022. It has declined since then, but remains slightly higher than the Fed wants it to be. Since then, mortgage rates have remained higher than home buyers want them to be. But they have trended downward since fall 2023.

Job growth

When the COVID-19 pandemic led to stay-at-home orders in the spring of 2020, the resulting layoffs and furloughs caused a recession. Mortgage rates already were low, and they fell even further — just as one would expect to happen in a recession. As the economy recovered and those jobs came back, mortgage rates went up.

Other economic indicators

Mortgage investors pay attention to many economic trends besides inflation and employment — including retail sales, home sales, housing starts, corporate earnings and stock prices.

Federal Reserve

The Federal Reserve doesn't set mortgage rates. The Fed raises and cuts short-term interest rates in reaction to broad movements in the economy. Mortgage rates rise and fall according to those same economic forces. Mortgage rates and Fed rates move independently of each other, but usually in the same direction.

» MORE: How the Fed affects mortgage rates

Are mortgage rates the same for all lenders?

Mortgage rates vary from lender to lender because lenders have different appetites for risk and different overhead costs.

When a lender reaches its capacity of loan applications its employees can process, it might keep rates slightly higher than necessary to keep from being overwhelmed; when business is slow, the lender might charge slightly lower rates to drum up business.

Shop with confidence

Because lenders' mortgage rates vary, it's smart to shop for a mortgage from several lenders because you could save thousands of dollars over the life of the loan.

And now that you understand how mortgage rates are determined, you're more equipped to ask smart mortgage questions when shopping for lenders.