How Mortgage Rates Are Set, and How to Get a Lower One
The Fed does not set your mortgage rate directly. Bond markets, your credit profile and the loan you choose do. Here is what you can control.
Key takeaways
- 30-year fixed rates tend to follow the 10-year Treasury yield, plus a spread.
- Your own rate depends on credit score, down payment, loan type and points.
- Compare the APR, not just the rate. APR includes most lender fees.
- On a conventional loan, PMI ends automatically once your balance reaches 78% of the original home value.
The market part of your rate
Most US mortgages are bundled into mortgage-backed securities and sold to investors. Those investors compare them with Treasury bonds. That is why the average 30-year fixed rate tends to move with the 10-year Treasury yield. The extra amount lenders charge over Treasuries, the spread, covers the risk that borrowers refinance early or default, plus lender costs.
The Federal Reserve sets a short-term rate. It affects mortgages indirectly, through expectations about inflation and the economy, which is why mortgage rates sometimes rise even after the Fed cuts.
The personal part of your rate
- Credit score. Higher scores get lower rates. The biggest jumps usually come at the 680, 720 and 740+ tiers.
- Down payment. A larger down payment lowers the loan-to-value ratio and the lender's risk.
- Loan type. Conventional, FHA, VA and USDA loans each price differently. FHA allows small down payments but charges mortgage insurance premiums.
- Term. 15-year loans carry lower rates than 30-year loans but higher monthly payments.
- Debt-to-income ratio. How much of your monthly income already goes to debt payments.
Points: paying now to save later
One discount point costs 1% of the loan amount and lowers your rate, often by about a quarter of a percentage point, though it varies by lender. On a $320,000 loan, one point costs $3,200. To decide, divide the cost by the monthly savings to find your break-even month. If you expect to sell or refinance before then, skip the points.
Rate vs. APR
The interest rate sets your monthly payment. The annual percentage rate (APR) folds in most lender fees and points, so it is better for comparing offers. Federal rules require lenders to give you a standard Loan Estimate within three business days of applying, which makes side-by-side comparison easier.
PMI, explained
With a conventional loan and less than 20% down, lenders require private mortgage insurance (PMI). It protects the lender, not you. Under the Homeowners Protection Act, you can ask to cancel it once your balance reaches 80% of the home's original value, and it must end automatically at 78% if you are current on payments. Our mortgage calculator drops PMI at that point.
Five ways to get a better rate
- Check your credit reports for errors months before you apply.
- Pay down credit card balances to lower your utilization.
- Get Loan Estimates from at least three lenders on the same day.
- Consider a larger down payment if it moves you into a better pricing tier.
- Lock your rate once you have an accepted offer, and ask how long the lock lasts.
This article is general education, not personalized financial advice. Read our editorial policy and disclaimer.
