American Mortgage Blog

Many people ask how mortgage interest rates are determined. Rates have climbed dramatically through May and into June, despite the feeling they should not have been increasing. The quick answer is that supply and demand set prices: the higher the prices, the lower the rates. But what determines supply and demand?

Anyone with a loan in process, or waiting to refinance, has seen rates move higher recently. A while back we wrote about the reasons interest rates might feel upward pressure this year. Granted, we have no crystal ball, but it is not hard to see why rates have been creeping up.

Borrowers who withdraw cash when they refinance are viewed as riskier than those who don't, because the cash withdrawal indicates possible financial distress, and that perception can raise a borrower's costs. This causes the rate on cash-out deals to be higher than on no-cash deals that are otherwise identical. The price difference is particularly large when the borrower's credit score is low.

Yes, rates have crept up from where they’ve been for many months. Borrowers often ask whether it is smart to spend “points” to lower their interest rate as a way to reduce their monthly mortgage payments. Paying discount points is where a borrower pays an upfront payment for a lower interest rate, and one point is 1% of the loan amount. So if you had a $100,000 mortgage, one point would cost $1,000 while two points would cost $2,000, etc.

Time has a way of moving quickly, and although June 1 seemed far in the distance several months ago, we are now less than two weeks from it. June 1 is the day that FHA's increase in MIP takes effect, and changes the length of time the borrower will be required to live with MIP. If a borrower has a decent credit score, a conventional loan with 5% down (conforming loans) might make much more financial sense.

The basic process of “doing” a loan is relatively simple: the borrower provides the lender documents proving that they are credit worthy, the lender reviews the documentation and the status of the property (underwriting) to verify that it is a sound risk, and then the money is lent. That being said, the process can take months, with the bulk of it being spent in underwriting the loan.

Underwriting guidelines change all the time. But interestingly, one thing that is somewhat constant is the amount of down payment due at the closing table. Many borrowers find, however, that coming up with the cash for the down payment has perhaps been the biggest obstacle to homeownership.

For years we’ve been hearing about the “shadow inventory,” but that chatter has died down recently due to modifications, refinancing, and investors and funds buying homes. There has been a great deal of attention paid to the vacuuming-up of "surplus" homes in places like Phoenix and Las Vegas by opportunistic investors, reducing the net-supply of unsold homes.

Borrowers often wonder how mortgage rates are derived, and how prices are determined. There are two basic sets of rate and price determinants that borrowers should be aware of which may clear up some of the confusion.

The press and the government continue to chatter about the home mortgage interest deduction. In this time of belt-tightening (and when don’t we seem to be in an era of belt-tightening?) it is an easy target to do away with or reduce. After all, other countries, like Canada, don’t have it. It is also an easy target since, generally, the richer you are, the more the home mortgage deduction helps you, right? Partly this is because you can only take the mortgage interest deduction if you forego the $12,000 standard deduction (for a married couple filing jointly), and that's a much bigger deal for working class families than wealthier families. It's also because as your income goes up, you're likely to have both a bigger mortgage and a higher tax rate.