To understand why mortgage rates change we must first ask the more general question, "Why do interest rates change?"

Interest rate movements are based on the simple concept of supply and demand. If the demand for credit (loans) increases, so do interest rates. This is because there are more buyers, so sellers (those who loan the money) can command a better price, i.e. higher rates. If the demand for credit reduces, then so do interest rates. This is because there are more sellers than buyers, so buyers can command a lower better price, i.e. lower rates. When the economy is expanding there is a higher demand for credit, so rates move higher, whereas when the economy is slowing the demand for credit decreases and so do interest rates.

• Bad news (i.e. a slowing economy) is good news for interest rates (i.e. lower rates).
• Good news (i.e. a growing economy) is bad news for interest rates (i.e. higher rates).
  

A major factor driving interest rates is inflation. Higher inflation is associated with a growing economy. When the economy grows too strongly, the Federal Reserve increases interest rates to slow the economy down and reduce inflation. Inflation results from prices of goods and services increasing. When the economy is strong, there is more demand for goods and services, so the producers of those goods and services can increase prices. A strong economy therefore results in higher real estate prices, higher rents on apartments and higher mortgage rates.

Mortgage rates tend to move in the same direction as interest rates. However, actual mortgage rates are also based on supply and demand for mortgages. The supply/demand equation for mortgage rates may be different from the supply/demand equation for interest rates. This might sometimes result in mortgage rates moving differently from other rates. For example, one lender may be forced to close additional mortgages to meet a commitment they have made. This results in them offering lower rates even though interest rates may have moved up!

There is an inverse relationship between bond prices and bond rates. This can be confusing. When bond prices move up, interest rates move down and vice versa. This is because bonds tend to have a fixed price at maturity––typically $1000. If the price of the bond is currently at $900 and there are 10 years left on the bond and if interest rates start moving higher, the price of the bond starts dropping. The higher interest rates will cause increased accumulation of interest over the next 10 years, such that a lower price (e.g. $880) will result in the same maturity price, i.e. $1000.

The first question customers usually ask when calling a mortgage company or lender is "What are your rates?" Because of the number of mortgage programs available and the various rate and point combinations, most mortgage companies have rate sheets that are 5-10 pages long.

Getting a rate quote is just a small part of shopping for a mortgage and usually not the best way to select a lender. Customer service, professional staff, convenience, and flexibility are some of the key attributes to selecting the best lender for your needs.

In helping you assess a rate, you will need to provide answers to a few basic questions like:

• What is your purchase price?
• What loan amount are you looking for or what loan amount do you want to finance?
• Do you prefer a fixed rate or an adjustable rate mortgage?
• How long do you plan to live in the house?
• How many points are you willing to pay?
  

The purchase price or the value of your home effects the rate because it effects the size of the loan. For example, Jumbo Loans, currently over $240,000, have a higher rate. Similarly, smaller loans have a higher rate or cost more because it cost the same and takes the same effort to do $35,000 loan as it does a $200,000 loan. Lenders and brokers need to make or charge a certain minimum amount of money to cover overhead, per loan (transaction) cost and make a profit.

The type of loan, fixed or variable for example, affect the rate because they affect the lenders income & inflation risk. For example, with a fixed rate loan, if rates go up the lender could lend out money at a higher rate than they are currently loaning it to you, and therefore earn more money. With a variable rate loan since the rate the lender can charge you changes regularly their income remains consistent with their current income opportunities.  Therefore with variable rate loans they give you a better rate since they know that if rates go up they can charge you more.

The length of time you will own a house affects both the type of loan you may want and the amount of points it may make sense to pay. For example, if you are going to keep a house for a short period of time (let’s say 3 years), you may be better off with a variable rate loan (e.g. a 3/1 ARM – fixed for 3 years and varies once a year every year there- after until the loan is paid off). Why? Because typically the 3/1 ARM has a lower rate associated with it than a 30 year fixed rate loan and since you will sell the house in 3 years you would not be affected by higher rates which may exist at that time. On the other hand, if you expect to live in the house for 30 years you might be willing to pay some points to receive a lower interest rate now. The lower interest rate would save you money every month over the life of the loan. The total savings in this situation should be greater than the cost of points, giving consideration to the amount that the point money could earn if invested (saved) after taxes.