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What are Mortgage Rates Based On, and What is a Mortgage Backed Security?

What are Mortgage Rates Based On, and What is a Mortgage Backed Security?

Your neighbor just refinanced their home at 4.5% and your wife’s parents downsized to a condo and got a new home loan at 3.85% — and you’re wondering, how do lenders come up with these rates?

We get this question frequently, and it’s a good one.

First, it helps to understand that mortgage rates are not “one-size-fits-all.” Rates vary by program – such as FHA versus conventional – and they vary by each person’s personal credit and financial history. To learn more about how a lender determines your mortgage rate, read our article, “Why Can’t I Get the Best Mortgage Rate?” In it, our Finance Director Dave Rafter explains the ins and outs of rates and how they’re calculated.

Second, it pays to know that mortgage rates quoted by lenders and brokers are based on Mortgage Backed Securities (MBS) — also known as Mortgage Bonds. If “Mortgage Backed Securities” sounds familiar, it’s because yes, they played a starring role in the real estate bubble and subsequent crash.

But they’re not the bad guys.

How Mortgage Backed Securities work

Traditionally, when a bank loaned you money to buy a home, it kept this loan on its books – which tied up its capital for years. To free up capital – and put it back to work – banks bundle these loans and sell each “packet” as a single bond to investment banks. Investment banks then sell these bonds to investors like you on the stock market.

Up until recently, this process worked well, mainly because the bar was pretty high with regard to getting a mortgage: you needed a solid credit history, a high credit score, a down payment and oh yes, a job.

The underlying foundation of Mortgage Bonds – mortgages being paid month after month by people banks had carefully “vetted” – was considered relatively low-risk.

But then came sub-prime loans and no-doc loans and suddenly, people were being approved for loans without having been duly vetted by lenders. Hence, the crash – both of the real estate and financial markets – as people defaulted on their loans.

Mortgage rates are tied to Mortgage Bonds

Mortgage rates are based on the prices of Mortgage Bonds – and these prices fluctuate daily / hourly since they’re bought and sold on the stock market. Prices for Mortgage Bonds can be affected by the President of the U.S. calling for war or by a low jobs number or any other type of news that affects the financial markets.

You can follow the mortgage rate news at Mortgage News Daily.

One thing to note: Mortgage rates are NOT based on the price of the 10-year U.S. Treasury Note. While the 10-year Treasury Note sometimes trends in the same direction as Mortgage Bonds, it is not unusual to see them move in completely opposite directions. DO NOT work with a lender who has their eye on the wrong indicators.

If you have any questions about mortgage rates – or you’re in the market for a new home loan or refi – give us a call. We’re here to help you. Be sure to take a look at our Customer Reviews page to see how we’ve helped hundreds of other people like you.

How a Mortgage Becomes a Mortgage Bond

Although not as entertaining as Schoolhouse Rock’s “I’m Just a Bill,” this video does a great job of quickly explaining how a mortgage becomes a Mortgage Backed Security.