What factors drive mortgage loan interest rates?

For millions of Americans, buying a home represents the largest financial decision they’ll ever make. At the heart of this decision lies a crucial number: the mortgage interest rate. This seemingly simple percentage plays a large part in whether your monthly mortgage payment is affordable or stretches your household’s budget to its breaking point. So, the goal for most buyers is to try and secure the lowest mortgage rate possible to try and keep their costs under control.

The mortgage rate environment has undergone significant shifts in recent years, though, making it more difficult to determine what the time is right to make a move. While it was easy to find rates in the 3% range during the pandemic, mortgage rates increased steadily throughout 2022 and 2023 — and at one point surpassed 8% on average. Rates have moderated a bit since that point — today’s average 30-year mortgage rate is 7.01% — but securing even a slightly lower rate could mean the difference between manageable monthly payments and a stretched budget. 

As a result, understanding the factors that drive mortgage interest rates may be more important than ever. By knowing what impacts mortgage rates, you’ll be better equipped to navigate the complex mortgage rate landscape when you embark on your homebuying journey. 

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What economic factors drive mortgage loan interest rates?

There are a few different economic factors that help to determine the baseline for mortgage interest rates, including:

Economic growth

The overall health of the economy plays a fundamental role in determining mortgage rates. During periods of strong economic growth, demand for credit typically increases as businesses expand and consumers make major purchases. This increased demand for borrowing tends to push interest rates higher. On the other hand, reduced demand for credit during economic downturns often leads to lower rates as lenders compete for fewer borrowers.

Inflation, which is a key indicator of economic growth, has a particularly strong influence on mortgage rates, as lenders must ensure that interest rates exceed the inflation rate to maintain the real value of their returns. When inflation rises, mortgage rates typically follow suit to compensate lenders for the declining purchasing power of future loan payments.

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Fed monetary policy

The Federal Reserve’s monetary policy decisions have both direct and indirect effects on mortgage rates. While the Fed doesn’t set mortgage rates directly, its federal funds rate — which is the rate banks charge each other for overnight loans — serves as a benchmark that influences all other interest rates in the economy.

As a result, the Fed’s broader monetary policy actions, such as quantitative easing or tightening, can significantly impact mortgage rates. During the 2020 pandemic, for example, the Fed’s purchases of mortgage-backed securities helped drive mortgage rates to historic lows. But when the Fed raises rates to combat inflation, which it did 11 times in 2022 and 2023, mortgage rates tend to rise.

The bond market

Mortgage rates are closely tied to the yield on 10-year Treasury bonds, often moving in parallel with these government securities. This connection exists because mortgage-backed securities compete with Treasury bonds for investors’ dollars. When Treasury yields rise, mortgage rates typically increase to remain competitive in attracting investor capital.

Global economic conditions and geopolitical events can also influence mortgage rates through their impact on the bond market. For example, during periods of uncertainty, investors tend to flock to the safety of the U.S. Treasury bonds, driving yields down and typically leading to lower mortgage rates.

The housing market

Supply and demand dynamics in the housing market itself can also influence mortgage rates. When housing demand is strong, lenders may raise rates to manage their loan volume and risk exposure. During housing market slowdowns, though, lenders might lower rates to attract borrowers and stimulate activity. The overall health of the mortgage industry, including default rates and foreclosure levels, can also affect rates. Higher default rates may lead lenders to increase rates to compensate for increased risk.

What personal factors impact your mortgage rate?

In addition to broader economic influences, there are personal factors that play a role in determining the mortgage rate you qualify for. These include:

• Credit score: Borrowers with higher credit scores typically receive lower interest rates, as they pose less risk to lenders.
• Loan amount and term: Larger loans or loans with longer repayment terms may come with higher rates, while shorter-term loans often have lower rates.
• Down payment: A larger down payment can reduce your mortgage rate by lowering the lender’s risk.
• Debt-to-income ratio: Lenders assess your debt-to-income (DTI) ratio to gauge your ability to manage monthly payments. A lower DTI can result in a better rate.
• Loan type: Different types of loans, such as fixed-rate or adjustable-rate mortgages, have varying interest rates.

The bottom line

Mortgage rates result from a complex interplay of economic forces, policy decisions and market dynamics. But while broad economic factors set the baseline for rates, numerous personal factors ultimately determine what rate a borrower receives. Understanding these various influences can help potential homebuyers make more informed decisions about when to enter the market and how to secure the best possible rate — especially as the economy continues to evolve and policy priorities shift.