Where do Mortgage Rates Come From

Sovereign Lending Group’s borrowers often wonder how mortgage rates are derived, and how prices are determined. There are two basic sets of rate and price determinants that our clients should be aware of which may clear up some of the confusion.

The first set of components that determine a particular mortgage’s rate and price is primarily quantitative, made up of numbers, ratios, and formulas, many of which come straight from Fannie Mae and Freddie Mac. Mortgage rates are derived from prices on securities backed by those same mortgages; those prices are a function of supply and demand: supply from lenders, and demand by investors. The value of servicing the loan is added, which includes how long the loan will be on the books, the property’s state, the likelihood of delinquency, etc. Loan-level pricing adjustments may be entered into the equation, depending credit score, loan size, and so on.

But that is not all. The key to margins over the past few years and including 2020-2021 has been capacity. What does that mean? A lender, or any company, basically can control the demand for its products by changing the pricing. If a company wants to slow things down because of capacity constraints, it can make its prices worse. If a company wants to adjust its competitive position in the marketplace, it changes its price. If a company wants to increase or decrease its profit margins, it adjusts its price. Finally, if a company wants to adjust its market share, it adjusts its price. In these respects, lenders are no different than any other for-profit business.

Sovereign, when setting the price for borrowers every day on our rate sheet, balance all of the above. Up until 2022 “the thumb” has been on the capacity side of the scale for several years for most of those in the industry. But what most borrowers don’t see, and articles don’t discuss, is the huge increase in costs that all lenders face. The MBA calculates it costs over $11,000 per loan! To offset that, and maintain business flow, margins have been cut by most in an effort to increase volume and market share.

Whether it is the increased cost of compliance due to the Consumer Finance Protection Bureau’s rules and regulations, or the higher costs of originating FHA, VA, Fannie Mae, or Freddie Mac loans, or the higher cost of servicing compliance and processing foreclosures, the cost of making a loan for lenders like Sovereign Lending Group has gone up. And unfortunately, borrowers will bear the brunt of it. Fortunately we have some very good programs to offset a portion of these higher costs: just ask us!