When you take out a home loan, you may assume that your lender is looking to make money off the mortgage interest you’ll be paying for years to come. The fact is, very few mortgage lenders work that way.
What Happens to Your Mortgage After You Finalize It?
Lenders are also called originators. They may be a bank, a credit union, or another type of financial institution.
Typically, they make their money through the fees they charge for originating the loan, relying on volume rather than long-term interest income to stay profitable.
A lender can keep a loan in its own portfolio, but most quickly sell their mortgages to investors via the secondary market. Those investors — not the lenders — are the ones who collect the interest payments over the life of the loan.
Lenders benefit from this arrangement because selling loans creates a constant infusion of cash they can use to originate more mortgages and collect more in fees. If lenders had to hold every loan on their books and wait for interest payments to trickle in month after month, cash flow would become a serious problem.
The secondary market keeps funds circulating so that loan originators don’t run out of money for new mortgages.
The Role of Fannie Mae, Freddie Mac, and the FHA
Mortgages are typically sold to investors through Fannie Mae, Freddie Mac, or the FHA — each of which requires that the loans they handle meet certain standards.
In return, they provide specific guarantees, making loans safer and more attractive to investors such as insurance companies, pension funds, and securities dealers.
Because these guarantees make mortgages more reliable, investors are willing to accept lower returns — and that savings trickles down to borrowers in the form of lower mortgage rates.
Fannie and Freddie buy mortgages and bundle them together for resale as mortgage-backed securities (MBS) — highly liquid investments that can be readily bought and sold.
The level of return investors expect is shaped by the current and anticipated condition of the economy. When the economy is on an upswing, future yields are expected to improve, so investors hold off buying until those higher yields materialize. That drives mortgage rates up because lenders can’t sell their loans at lower yields.
When the economy is in a downturn, investors buy up available securities to lock in returns before yields fall further — pushing mortgage rates down in the process.
The Federal Reserve’s Role in Mortgage Rates
Another metric worth watching is the federal funds rate — the rate that banks charge each other for overnight loans of reserves held at the Federal Reserve.
The federal funds rate is set by the Federal Open Market Committee (FOMC), which also regulates the buying and selling of U.S. Treasuries and federal agency securities. The FOMC holds eight meetings each year, reviewing economic and financial conditions and adjusting monetary policy to keep the economy stable.
A decrease in the rate stimulates economic growth; an increase slows it. In periods of high inflation, the FOMC may raise rates — and when the economy needs a boost, rates are lowered.
These decisions have a direct impact on mortgage rates. For example, a 0.25% increase on a $250,000 home loan adds roughly $35 to your monthly payment. That may not sound like much, but a full percentage point increase can significantly affect affordability — especially if you’re budgeting tightly or timing a home purchase.
The federal funds rate also influences the stock market, and the two affect each other in turn. If markets are struggling, the FOMC may cut rates to free up the money supply. If markets are overheating, the Fed may raise rates to cool things down.
Taken together, unemployment levels, inflation, stock and Treasury bond market trends, and the federal funds rate all play a role in shaping mortgage rates. No single indicator will give you a perfect forecast, but tracking them together can give you a clearer sense of where rates may be headed.
It’s also worth noting that adjustable-rate mortgages (ARMs) tend to follow Fed moves more closely than fixed-rate mortgages, rising and falling more quickly in response to rate changes.
More Challenging to Qualify for a Loan
Higher interest rates mean higher monthly payments — and that can push some borrowers out of the market entirely, either because they can’t afford the higher payment or because it throws off their debt-to-income ratio.
Higher home loan payments can increase a debt-to-income ratio, preventing some people from qualifying for a loan.
Less buying power can also slow the rise of home prices as fewer buyers compete for the same properties — potentially moderating price increases and making homes more accessible, even as borrowing costs climb.
If rates have shifted since you last locked in your mortgage, it may be worth exploring whether a refinance could lower your monthly payment or improve your loan terms. See what rate you qualify for with Refi.com.
