HOW ARE MORTGAGE RATES DETERMINED?
This depends on whom you ask, if you’re working with a
self-described “mortgage rock star” they will tell you that they are where good
rates start and end, there are no others that can compete. This is BS, the truth is that rates start
with mortgage backed securities and end with loan level pricing adjustments.
MORTGAGE BACKED SECURITIES DO PLAY A ROLE, BUT NOT THE WHOLE ROLE
I won’t get into mortgage backed securities (MBS) in this post, but you can check here for my video explaining MBS and how they relate to exactly how are mortgage rates determined. MBS set the stage for rates, and loan level pricing adjustments (LLPA’s) are the real drivers. Have you ever heard somebody say that investment property loans carry higher rates? I’m here to tell you that investment property loans do not carry higher rates, the rates are the same because the rate is just a number, but the cost to obtain a specific rate is what changes. Are you confused yet? Good, I’ll make it clear in a minute.
How are mortgage rates determined?
That depends on very specific criteria of your particular mortgage. All of these will establish what your rate will be, and the cost associated with that rate: credit rating, loan term, purpose of the loan, loan to value, combined loan to value, occupancy, and property type. Fannie Mae and Freddie Mac have something called LLPA’s, those are costs, or credits, that the borrower receives based on the differing criteria that I outlined above. There are over 55 LLPA adjustments just for Credit Score and Loan to Value on a 30 year fixed rate mortgage!! There are another 28 if you are doing a cash out refinance!! For instance, if you are a top notch borrower with a stellar credit rating of 760, and you are refinancing your primary residence with a loan to value of 50%, and not pulling any cash out, your base rate would be 3.625%. If your credit is 620-639 and the loan to value is 80.01-85% that same rate would cost you 3.375% of the loan amount because of these pricing adjustments. What if the really good credit borrower decided to pull cash out, how would that change the rate? They would receive the same rate of 3.625%, but now Fannie Mae and Freddie Mac charge a cost for taking cash out of .25% as long as the loan to value remains under 60%. The thought process for these lending giants is that a cash out refinance carries a higher risk, therefore they receive a higher return. If this property was an investment property instead of your primary residence the LLPA for that would be an additional 2.5% of the loan amount in cost. Again, investment properties are a greater risk than primary residence refinances and so the lender gets the risk/reward feature. If the borrower doesn’t want to pay the costs associated with these LLPA’s they can request a higher rate from the lender, and in turn the lender will provide a credit to the borrower which offsets all, or a portion of, the costs of the LLPA’s. And this simple reason is why investment properties carry higher rates, most borrowers choose not to pay the cost that comes with the LLPA’s and instead choose a higher rate to offset that cost. So, when someone asks, “How are mortgage rates determined?, you can see that it is not a simple answer. North Bay Capital stands at the ready to help you or your clients determine what their rate will be in a straightforward and clear manner. Also, if you ask us and our clients’, we are where good rates start and end, there are no others that can compete.