How Do Mortgage Interest Rates Work?
We’re answering your top questions about mortgage interest rates including how they are determined, why they go up or down, and when it makes sense to lock them in.
In simple terms, interest rates are what consumers are charged by a financial institution to borrow money. In the current economy, interest rates – especially mortgage interest rates - have taken center stage.
As consumers consider refinancing or applying for a new mortgage, they may be wondering:
- How are mortgage interest rates determined?
- What causes them to go up or down?
- When is the best time to lock in your interest rate?
- How does the mortgage interest tax deduction work?
Here are answers to these four essential questions about mortgage interest rates.
Mortgage Interest Rate Question #1: How are mortgage interest rates determined?
If you’re not entirely sure how mortgage interest rates are determined, you’re not alone. How home loan rates are set is often misunderstood.
In general, U.S. Treasury bills, bonds, and notes influence mortgage interest rates. More specifically, home loan rates are determined by the bond market, including mortgage bonds and mortgage-backed securities. Because most home loans are bundled by lenders and sold on the bond market, home loan interest rates are most dependent upon how that market is performing.
A common misconception is that the Federal Reserve determines mortgage rates. When the Fed lowers interest rates, it is often assumed that mortgage rates will also decrease. This is not always the case. Adjustable-rate mortgages, or ARMs, can be influenced by the Fed — but not fixed-rate mortgages. It’s important to understand, however, that the Fed can impact mortgage rates indirectly since its actions often affect the economy, inflation, and the decision-making of investors.
Mortgage Interest Rate Question #2: Why do mortgage interest rates go up or down?
Mortgage-backed securities are the most significant contributor to mortgage rate changes, along with various economic factors. Since home loans are packaged into bundles — also known as mortgage-backed securities — and sold on the bond market, lender and investor risk appetite for those securities can cause mortgage rates to fluctuate.
In general, investors typically favor bonds when the economic outlook is poor. When purchases of bonds increase, mortgage interest rates decrease. The opposite is also true. When the economy is doing well, stocks become more favorable, forcing bond prices lower and increasing mortgage interest rates.
Keep in mind that in addition to the purchase and sale of bonds, many factors can cause rates to go up or down, which makes forecasting rate changes difficult. If you are curious about the direction of home loan rates for the remainder of 2019, government-sponsored mortgage facilitator Fannie Mae recently released a forecast for 30-year fixed mortgage rates. Bear in mind that forecasts are not guaranteed and can be inaccurate.
Curious about home loan interest rates in Idaho and Utah? Contact a Zions Bank mortgage lender in your area for local assistance with the home-buying process.
Mortgage Interest Rate Question #3: When does it make sense to lock in a rate?
If you search online for mortgage interest rates, you’ll likely find an average, rather than a precise rate that applies to your individual application. Interest rates are affected by factors such as your credit score, loan amount, down payment, and economic conditions. These factors combine to determine what interest rate is available to you as a borrower.
Once your personalized mortgage interest rate is determined, you can lock in that rate when you apply for a home loan.
You can also wait and see if a lower rate becomes available between the time of your application and your closing date. With the latter strategy, however, there is risk involved. You might be tempted to wait and see if a lower rate becomes available, but keep in mind that the opposite could also happen.
If mortgage rates increase, you may lose some of your initial home-buying power, which could jeopardize your home purchase.
If you’re looking to score the best interest rate on your home loan, consider these 5 Strategies for Shopping for the Best Mortgage Rate.
Mortgage Interest Rate Question #4: Can home loan interest be deducted on taxes?
The simple answer is yes, mortgage interest is tax-deductible. Homeowners can use IRS Form 8396 to deduct mortgage loan interest from their taxable income.
There is a more complex answer, though. With the passage of the Tax Cuts and Jobs Act, you must now itemize your tax deductions if you wish to claim mortgage interest. If you choose to itemize, you must also forego the standard deduction, which increased significantly for the 2019 tax year.
For 2019, the standard deduction amounts will be $12,200 for individuals, $18,350 for heads of household, and $24,400 for married couples filing jointly. For some homeowners, itemizing may be a wise tax decision, but most will likely claim the standard deduction.
Be sure to consult with your tax advisor to understand how tax laws may apply to your situation.
Want to learn more? Visit the Zions Bank Home Loan Learning Center to compare home loans, answer your mortgage questions and discover additional mortgage resources.
Ali Hardy is a freelance writer for Zions Bank.