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How Do Lender’s Determine Interest Rates?

Contrary to popular belief, the reality is that rates are driven largely by factors outside of the Lender’s control.  The primary source of information that Lenders use to determine rates is known as the Secondary Market.

This market is a composed of lenders, brokers, banks and investors who buy loans.  These loans can be sold as pools of loans to other investors or the investors can retain them for their earnings.

The end investors are willing to pay a certain price for these pools of loans and that market price is what impacts mortgage rates, these are referred to as Mortgage Backed Securities (MBS).

Due to the reduced risk as compared to other investments available to them, the investors will generally agree to a lower rate of return on these Mortgage Backed Securities.  The perception of reduced risk is due to the fact that the loans are secured by real property and also because they have implied government backing. Fannie Mae and Freddie Mac are the quasi-governmental agencies.   These agencies govern the Secondary Market.  Loans must be compliant with the guidelines set forth by these two agencies in order to be bundled and sold on the secondary market.

Mortgage rates closely follow the movement between stocks based on earnings and profit vs. real property to dictate mortgage rates.   Interestingly, mere speculation about the economy and market perception alone can and does cause much of the fluctuation with mortgage rates.

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