Kenneth Wohl of SpiritBank recently put together this explanation, and I thought it’d be useful to you, my clients, so with his permission, here it is.  Hopefully it’ll help us all understand things a little better.

Spotlight– How Interest Rates are Set
 
One of the most commonly misunderstood facets of Mortgage lending is how rates are arrived at daily.  While many think that a lender simply sets a rate arbitrarily, the exact opposite is true.  In fact, mortgage rates are simply a function of the free market– Good Old Supply & Demand are at work setting prices and rates.
 
Every day Billions of dollars worth of Mortgage Backed Securities (MBS) are traded back and forth in the Capital Markets.  As these are Bond/Credit instruments their rate or yield moves the opposite direction of their price.  When a bond price goes up, the rate or yield goes down.  When a bond price moves down then the rate/yield increases because a higher rate should attract a buyer to purchase that bond.
 
Every morning and through the day, we receive rate updates on each of our programs from our secondary market investors who purchase our loans after closing.  Their rates are set based on the activity in the Bond/Credit markets for that day.  Typically, when economic news and outlook is gloomy, like higher unemployment; that is actually good for rates because bonds are seen as safer than stocks.  Good economic news tends to push rates higher as Stocks become more attractive to investors and bonds are not as attractive in terms of investment return.  Bonds are somewhat safer than stocks since they have a claim on the issuer’s assets.  As such, they benefit from when money flows out of stocks looking for a safe haven to set while they await their next investment move.
 
As investors want more and more of a particular mortgage bond, like those backed by FHA loans, we have seen the FHA rates fall faster than that of conventional loans.  There are many different factors that can move the markets from the price of Oil to political events like terrorist attacks and elections, to natural disasters and economic supply shocks.  However one thing remains true, in the good ol’ USA the market still reigns supreme in setting the price of money– Interest Rates
 
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