DEFINITION of 'Mortgage Rate'
Mortgage rates are the rate of interest charged on a mortgage. They are determined by the lender in most cases, and can be either fixed, stay the same for the term of the mortgage, or variable, fluctuate with a benchmark interest rate. Mortgage rates rise and fall with interest rates and can drastically affect the homebuyers' market.
BREAKING DOWN 'Mortgage Rate'
A mortgage is the loan taken out to finance a home. It consists of multiple parts, including collateral, principal, interest, taxes and insurance. The collateral on a mortgage is the house itself, and the principal is the initial amount for the loan. Taxes and insurance vary according to the location of the home and are usually an estimated figure until the time of purchase. The interest charged is known as the mortgage rate.
Mortgage Rate Indicators
The biggest indicator for a high or low mortgage rate is the 10-year Treasury bond yield. If the bond yield rises, the mortgage rates rise as well. The inverse is the same; if the bond yield drops, the mortgage rate typically also drops. Even though most mortgages are calculated based on a 30-year timeframe, after 10 years, many mortgages are either paid off or refinanced for a new rate. Therefore, the 10-year Treasury bond yield is a good standard to judge.
The current state of the economy is also a good indicator for estimating a mortgage rate. If the economy is bad, investors turn to bonds to secure their money, and the bond yield drops. Mortgage rates become lower, and therefore more attractive to borrowers. If the economy is flourishing, investors seek other investment opportunities, and the bond yield rises, increasing mortgage rates.
Determining a Mortgage Rate
A lender assumes a level of risk when it issues a mortgage, for there is always the possibility a customer may default on his loan. There are a number of factors that go into determining the mortgage rate, and the higher the risk, the higher the rate. A high rate ensures the lender recoups the initial loan amount at a faster rate in case the borrower defaults, protecting the lender's financial investment.
The borrower's credit score can often play a role in the rate charged on a mortgage and the size of mortgage loan he is able to obtain. A higher credit score indicates the borrower has a good financial history and is more likely to repay his debts. This allows the lender to lower the mortgage rate because the risk of default is lower. The rate charged ultimately determines the overall cost of the mortgage and the amount of the monthly payment. Therefore, borrowers should always seek the lowest rate possible.