Mortgage rates are affected by the borrower’s credit score, debt to income ratios and other characteristics, but they also depend on economic and governmental factors. In the U.S., the Federal Open Market Committee is responsible for setting a range of interest rates that lenders are allowed to charge when extending credit. Borrowers are assigned a rate that corresponds to the risk they present to their lender. The ranges are largely determined by external factors, including those discussed below.
Inflation. As goods and services become more expensive over time, the value of money decreases as fewer items can be purchased for the same amount of money. This is called inflation. When the value of a dollar decreases, lenders have to find a way to increase the purchasing power on their returns. They do this by raising interest rates to collect more from borrowers. So, if inflation rises by 2%, lenders will need to increase interest rates by at least 2% to protect their investment.
Economic Health. In a booming economy, more people can afford to buy homes because salaries are generally higher. This drives up the demand for loanable funds from mortgage companies. With more people needing mortgages, lenders can charge higher interest rates and still attract buyers. In a slower economy, fewer people can afford to buy a home and lenders have to lower interest rates to attract buyers.
Federal Policy. Although interest rates are set by the condition of the open market, the federal government has a lot to do with interest rates as well. The Federal Reserve is responsible for controlling the amount of money that is being circulated through the economy and they use this as a tool in directing the economy. If the Federal Reserve increases the amount of money being circulated, interest rates decrease, and vice versa. This is similar to the effect that economic health has on interest rates because the availability of money is what drives the rise and fall of interest rates.
Although individual borrowers can’t control the economic or governmental factors of interest rates, they can still do their best to help these factors work in their favor. Maintaining a good credit score and steady finances will help them to be ready to borrow when the time is right. Monitoring economic trends will help borrowers to decide when would be the right time to buy and when it would be better to wait.