How to read the rate environment

Mortgage rates appear in headlines, advertisements and conversations with friends, often with a tone suggesting you should act immediately. Understanding what actually moves rates, and why the rate in a news story may not be the rate you are offered, can help you follow the rate environment calmly and ask lenders more informed questions.

What tends to move mortgage rates

Mortgage rates are not set by any single authority. They emerge from the interaction of several forces:

• Longer-term bond yields. Mortgage rates tend to move broadly in the same direction as yields on longer-term U.S. Treasury securities, because investors compare mortgage-related investments with other long-term, relatively safe assets.
• Demand for mortgage-backed securities. Many mortgages are pooled and sold to investors as mortgage-backed securities. When demand for those securities changes, lenders' pricing often changes with it.
• Inflation and inflation expectations. Lenders and investors generally want a return that keeps pace with inflation, so rising inflation expectations tend to push rates up.
• Economic data. Reports on employment, growth and consumer prices may move bond markets and, in turn, mortgage pricing.
• Lender capacity and competition. When lenders are very busy, or competing hard for business, their pricing may shift independently of the wider market.

The role of the Federal Reserve

The Federal Reserve sets a target for the federal funds rate, which is the rate banks charge each other for overnight lending. That rate directly influences short-term borrowing costs, including many credit cards and home equity lines of credit tied to the prime rate.

The relationship with longer-term fixed mortgage rates is less direct. Markets often anticipate Federal Reserve decisions well in advance, so mortgage rates may move before an announcement rather than after it. It is possible for the Federal Reserve to lower its target while mortgage rates hold steady or even rise, depending on what bond markets expect about inflation and growth.

Why the headline rate is not your rate

Published averages and advertised rates usually assume a particular borrower profile, loan type and set of conditions. The rate you are offered may differ based on your credit history, the size of your down payment or your equity, the loan type and term, the property type, whether the home is a primary residence, and whether you pay points.

Points, sometimes called discount points, are fees paid at closing in exchange for a lower interest rate. An advertised rate may assume points are being paid. When comparing offers, ask whether the quoted rate includes points and what they cost.

Interest rate and APR

The interest rate determines the interest charged on your balance. The annual percentage rate, or APR, is designed to reflect the broader cost of borrowing by including certain fees and charges along with the interest rate. Because of this, the APR is often higher than the interest rate. Comparing APRs can help you see differences in fees between offers, although APR has its own limitations. It assumes you keep the loan for its full term, which many borrowers do not.

Rate locks

Once you have an accepted application, a lender may offer to lock your rate for a set period while the loan is processed. A lock protects you if rates rise before closing, but it typically expires if closing is delayed beyond the lock period, and extensions may carry a fee. Some lenders offer a float-down option that lets you take advantage of a drop in rates during the lock, often at an additional cost. Ask how long the lock lasts, what it costs, what happens if it expires and whether a float-down option exists.

Following rates without trying to predict them

No one can reliably predict where mortgage rates will go next, including professional forecasters. Rather than trying to time the market, many people find it more useful to focus on what they can control: preparing their credit, understanding their budget, gathering documents and knowing what a given payment would mean for their finances.

• Follow trends over weeks and months rather than reacting to single-day moves.
• Read past the headline and check what loan type and borrower profile an average describes.
• Use a calculator with your own numbers to see how a change in rate would affect a payment, keeping in mind that the illustration leaves out taxes, insurance and fees.
• Request written estimates from lenders on the same day, so you are comparing offers made under the same market conditions.