So far, down this little Mortgage 101 rabbit hole, we’ve talked about what an interest rate actually is, why the rate alone doesn’t tell you whether you’re getting a good deal, and how the price attached to a rate can change even when the rate itself doesn’t.
Which brings us to the next logical question: who the hell decides what mortgage rates are in the first place?
Because contrary to what a whole lot of headlines would have you believe, there is no Wizard of Oz at the Federal Reserve hiding behind a curtain and cranking mortgage rates up and down.
Does the Fed matter? Yep. Its decisions and what it signals about inflation—and the economy in general—absolutely influence how investors behave. But it’s influence, not a dial. (And honestly, that one deserves its own rabbit hole.)
Mortgage rates are market-driven, and a huge part of that comes back to what investors are willing to pay for mortgages as profitable investment tools.
Wait. My mortgage is someone’s investment?
To YOU, a mortgage is money you borrowed to buy a house. To whoever’s on the other side of that deal, it’s a paycheck that shows up every single month for years.
Remember from our first Mortgage 101 conversation: lenders are willing to loan money because they expect to be compensated for letting you use that money. But the lender who originally gives you the mortgage does not necessarily plan to sit there collecting your payments for the next 30 years.
A massive number of mortgages eventually make their way into the secondary mortgage market, where similar loans are bundled together into mortgage-backed securities (or MBS). Investors can buy those securities and receive cash flows generated by the mortgages inside them.
So when I talk about “investors” affecting mortgage rates, I am not talking about some random dude buying your individual mortgage on Facebook Marketplace. I’m referring to the enormous financial market where mortgages become investments.
*I highly recommend watching the movie The Big Short for a deep dive into how this relates to the Housing Crash in 2008.
Mortgages behave a lot like bonds...with one annoying little twist.
If “bond” makes your eyes glaze over, here’s all you need to know: a bond is basically an IOU. An investor hands over money today, and in exchange they get paid back over time, with interest. U.S. Treasury securities are one example (that’s the government borrowing). Mortgage-backed securities are another (that’s, well...this conversation).
Mortgage-backed securities live in the broader fixed-income world, which is why you’ll frequently hear mortgage people talking about bonds and Treasury yields when rates are moving.
The basic idea is pretty straightforward: an investor puts money out today with the expectation of receiving income returns over time. U.S. Treasury securities are one example. Mortgage-backed securities are another.
But they are not identical investments.
One VERY important difference is that mortgage borrowers have a habit of doing whatever the hell they want with their houses. We sell them. We refinance them. We pay extra principal. Sometimes we pay the mortgage off YEARS before the original loan term ends.
That sounds wonderful from the borrower side—yay, debt-be-gone—but it creates something called prepayment risk for the investor.
Let’s say an investor likes your mortgage because it is producing a nice return and they expect those payments to continue for quite a while. Then two years later, rates fall and you refinance.
You are thrilled.
The investor gets their principal back, but they also lose all the future interest payments they were expecting from your mortgage. Now they have to take that money and reinvest it in whatever the market looks like then, which may be offering substantially lower returns.
That uncertainty has a cost, which is one reason mortgage-backed securities generally need to offer investors a higher return than something considered safer and more predictable, like a U.S. Treasury.
And suddenly we’ve arrived at why bond-market nerdiness ends up affecting the mortgage quote sitting in your inbox.
Investor demand affects mortgage pricing.
Here’s the basic relationship: when investors are really interested in buying mortgage-backed securities (like when the stock market is getting wild), they are willing to pay more for them. When they are less interested—like when inflation is high and those fixed payments are worth less, or when other investments offer a better return for the risk—they demand more yield to make mortgages attractive.
And here’s the part that trips people up: when investors pay MORE for mortgage-backed securities, the return they get on them goes DOWN, and mortgage rates tend to follow. When demand dries up, prices drop, the return goes up, and so do rates. Popular mortgages = cheaper money. Unpopular mortgages = pricier money.
It’s also one of the reasons mortgage rates can change every day, sometimes multiple times in the same day. Mortgage-backed securities are being bought and sold in an active market, and they aren’t just competing with other mortgages for investor money. Investors have options: Treasuries, corporate bonds, stocks, and a giant universe of other places that make their cash earn more cash. Mortgages have to look like a sweet deal compared to all of it.
This is also why the 10-year Treasury gets talked about so much in mortgage-land. Not because 30-year mortgage rates magically follow it point-for-point. They absolutely do not.
It’s more like a measuring stick. Treasuries are about as safe and predictable as investments get, so investors use them as a baseline, and mortgage-backed securities have to pay a little extra on top to make up for the risks Treasuries don’t have. (See conversation on prepayment risk.)
So why the 10-year and not a 30-year bond? Remember all those people selling, refinancing, and paying their mortgages off early? Because of that, most 30-year mortgages don’t actually last anywhere near 30 years, so investors compare them to something closer to their actual reality.
So why doesn’t everybody get the same rate?
Because now we have to separate the market from your loan.
The broader mortgage market helps establish the starting environment for pricing. Then your specific loan gets dropped into that environment, and your loan has its own characteristics (and layers of perceived risk).
Your credit profile matters. Your down payment—or more specifically, your loan-to-value ratio—matters. Whether you are buying a primary residence, second home, or investment property matters. Whether you are purchasing or refinancing matters. The loan program matters. And they all matter quite a bit.
This is why your friend/sister/cousin saying, “I got ___%!” still tells me almost nothing about what you should be getting.
Different borrower, different location, different down payment, different loan, possibly different day/market.
We have several strong variables at play.
But does a lower credit score always mean a higher rate?
This is where I want to be annoyingly precise, because simplified mortgage education has a way of turning “this factor affects pricing” into “this factor always changes your rate by exactly X.”
No.
Credit can absolutely affect mortgage pricing. So can loan-to-value and other characteristics. But those adjustments do not necessarily show up as a clean, direct increase in your actual note rate.
Remember the last article? Rate + price.
A pricing adjustment may first change the cost associated with a particular rate. Depending on how you structure the loan, that can ultimately affect the interest rate you choose, the upfront cost you pay, or some combination of the two.
This is why I would rather tell you that credit affects pricing than casually say, “Lower credit score = higher interest rate.”
The second version is easier. The first one is more accurate.
And I am a giant fan of accurate.
Why rates can move even though nothing about YOU changed
This is probably the most useful distinction in the whole conversation.
There are things that change because the market changed, and there are things that change because your loan changed.
If your credit score is exactly the same, your down payment is exactly the same, your loan program is exactly the same, and nothing about your scenario changed from Tuesday to Wednesday, your mortgage pricing can STILL be different on Wednesday because the market moved.
Conversely, the overall market could be relatively unchanged while your individual pricing changes because you changed the down payment, switched loan programs, changed property types, or some other characteristic of the transaction changed.
Those are two completely different reasons for a quote to move, and knowing which one happened matters.
Otherwise we end up blaming “the market” for something that changed in the loan, or thinking a lender randomly changed the rate when the underlying mortgage market actually moved.
Neither is particularly helpful.
And THIS is why mortgage rates can feel so damn complicated
There is not one single lever controlling them.
There is an enormous market determining what investors are willing to pay for mortgage-backed securities and what return they require for taking the associated risks. Then there is the specific mortgage sitting in front of us, with its own borrower, property, loan program, credit profile, loan-to-value ratio, and other characteristics affecting how that loan is priced.
And then—because apparently mortgages were not complicated enough already—we still have your choice of which rate-and-cost combination makes the most sense.
Market pricing. Loan-level pricing. Your actual strategy.
Three related things. Not the same thing.
So when mortgage rates move tomorrow, it is not because somebody somewhere simply decided homebuyers should pay more. Something changed in the value of the underlying financing.
And when YOUR quote is different from someone else’s, that does not automatically mean one of you got a better lender. It may simply mean you are not pricing the same mortgage.
That’s the piece I want you to understand before we go any farther down this particular rabbit hole.