QUESTION
I am a new loan officer working for a mortgage broker. I graduated from college two years ago, and I still live with my parents because I can't find a decent job. A friend became a loan officer and said I should do it too. So, I got involved as a side hustle. I've been doing this for nine months.
At this point, I have made loans for a few family members and a good friend, and I have 6 loans in the pipeline from real estate offices. My borrowers always talk about the rates. It's probably their number one question. They then ask me to explain how rates are determined. No matter how I explain it to them, they get confused, and I don't blame them. The rate is always changing and seems unpredictable.
How should I explain interest rates to my borrowers?
Thank you!
A Newbie Loan Officer
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OUR ANSWER
For my response, I am going to assume that your loan applicant is not particularly interested in the secondary and capital markets, the factors that determine mortgage rates, or the securitization factors that affect them.
That said, I am going to assume that you want a straightforward explanation that you can provide to your loan applicants. I hope to offer a non-technical view that they will understand while you are sitting with them to take the loan application.
As a new loan officer, please note that when the applicant is sitting down to take the application (or interacting with you online), the point of sale is often a make-or-break moment.
The point of sale is the most important part of loan sales because it is the primary point where trust is established between the loan officer and the applicants. If you can't explain how mortgage rates are determined, you can lose their trust in your expertise, a factor that could determine if they go with you or somebody else.
Components that Determine Mortgage Interest Rates
There are essentially two significant components that determine mortgage interest rates: market and economic conditions, and what I'll call personal and lender-specific influences.
Let's consider each of them.
Market and Economic Conditions
Several market and economic factors affect the baseline for all mortgage rates and are largely outside a borrower's control.
Let's discuss!
Bond Market & Treasury Yields
Mortgage rates are directly tied to the yields on U.S. Treasury notes, particularly the 10-year Treasury yield, and mortgage-backed securities (MBS). These are considered "safe havens" for preserving financial assets. When investor demand for these safe-haven assets increases – most often during times of economic uncertainty – yields, and thus mortgage rates, tend to fall. Conversely, low demand pushes rates up.
Now, this may confuse your borrowers. So, you should tell them that these financial instruments work inversely to interest rates because their "fixed coupon" payment becomes more or less valuable as new such financial instruments offer different rates. So, when market rates rise, existing bonds with lower fixed payments become less attractive, and their prices fall to a competitive yield; and when rates fall, existing bonds become more valuable, and their prices rise. This inverse relationship means if you sell an old bond when rates are up, you'll get less; if you sell when rates are down, you'll get more.
Inflation
High inflation leads lenders and investors to demand higher interest rates to offset the erosion of the purchasing power of future payments. When inflation is low, rates tend to be lower.
An example would be when high inflation prompts the Federal Reserve to raise interest rates, making mortgages more expensive (for instance, from 3% to 6%). Hence, a buyer of a $300,000 home pays more monthly, and when investors demand higher yields on bonds to compensate for their future earnings, they buy less. At the same time, low inflation allows for lower borrowing costs, stimulating spending and investment.
