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.
Federal Reserve Policy
The Federal Reserve influences, but does not directly set, mortgage rates. In seminars I have given, I've found that some people don't realize the Federal Reserve doesn't set mortgage rates. Its decisions on the federal funds rate (the overnight lending rate between banks) affect short-term borrowing costs and ripple through the entire financial system, including the longer-term mortgage market.
However, the Federal Reserve exerts significant influence through several channels. Take, for instance, the cost of funds: when the Fed raises rates, it becomes more expensive for banks to borrow, a cost they often pass on to consumers in the form of higher mortgage interest rates.
Short-term benchmarks – such as Adjustable Rate Mortgages (ARMs) and Home Equity Lines of Credit (HELOCs)- are affected; they often adjust shortly after a Fed move.
Long-term fixed-rate mortgages (like the 30-year fixed rate mortgage) are closely tied to the 10-year Treasury yield rather than the Fed rate. The mortgage market is affected by adding a "spread" (usually between 1.5 and 3 percentage points) to the 10-year Treasury yield to cover risk and costs. And, if the Fed signals aggressive future rate hikes to fight inflation, Treasury yields – and mortgage rates – often rise in anticipation, even before the Fed officially acts.
Economic Growth & Job Market
Here's a rule of thumb: a strong economy with high employment and consumer spending tends to lead to higher mortgage rates as demand for loans increases, whereas a weaker economy often results in lower rates to stimulate borrowing and spending.
Personal and Lender-Specific Influences
Many factors influence these rates; however, I will mention the most compelling factors that account for variation in the specific rate offered to a borrower, which usually reflects the borrower's financial profile.
So, let’s discuss!
Credit Score
A higher credit score (typically 740 or above for the best rates) indicates a lower risk to the lender, resulting in a lower interest rate. This is a core principle in finance and lending. Risk and rate are fundamentally linked: higher risk demands higher rates as compensation (measured in interest and returns), while lower risk allows for lower rates. That said, the specific relationship (for instance, interest rate risk in bonds versus credit risk in loans) varies in application, often involving inverse or direct correlations depending on the context.
Down Payment and the Loan-to-Value Ratio (LTV)
A larger down payment reduces the amount borrowed relative to the home's value (thus, lower LTV), making the loan less risky for the lender and leading to a better rate. Of course, a borrower can generally use extra cash instead of a larger down payment to "buy points" (called discount points). The arrangement is called buying down the rate. This is an upfront fee paid to the lender in exchange for a permanently lower interest rate.
Loan Term and Type
Shorter-term loans (for instance, the 15-year fixed-rate loans) generally have lower interest rates than longer-term loans (such as the 30-year fixed-rate loan) because the lender's risk is lower over a shorter period. Government-backed loans (FHA, VA) may also offer different rates than conventional loans.
Debt-to-Income Ratio (DTI)
A lower DTI ratio, which compares the monthly debt payments to the gross monthly income, signals to lenders that the borrower has more capacity to manage their mortgage payments, which helps secure a better rate.
The DTI ratio is a critical factor. It heavily influences mortgage rates by signaling risk to lenders; to wit, a lower DTI indicates the borrower can handle payments, leading to better approval odds and lower interest rates. In comparison, a higher DTI suggests financial strain, potentially resulting in higher rates, stricter terms, or even loan denial, as it signals higher risk.
Property Type and Occupancy
A primary residence typically has a lower rate than a second home or investment property, as lenders assume less risk. In seminars I have conducted, some attendees do not fully understand how property type and occupancy significantly influence mortgage rates. Primary residences get the lowest rates due to lower risk, followed by secondary homes, and then investment properties, which carry the highest rates because borrowers are more likely to default on them during financial hardship. Non-traditional property types, such as condos or manufactured homes, often command higher rates than single-family homes.
This risk is not contrived on the basis of a lender's intuition. Quantitative analyses over many decades have conclusively shown that risk increases or decreases depending on property type and occupancy. Lenders assess the likelihood of a borrower defaulting. They believe the borrower will prioritize paying for their own home (that is, the primary residence) over a rental or vacation home, making investment and second homes riskier and thus more expensive to finance.
Mortgage Points
Borrowers can pay mortgage points, which are a form of prepaid interest, at closing to buy down their interest rate. I discussed this factor above in the Down Payment and Loan-To-Value Ratio section. Mortgage points, also called discount points, are prepaid interest the borrower pays upfront to the lender to permanently lower the mortgage's interest rate, typically by about 0.25% per point, with one point costing 1% of the loan amount.
Buying points reduces the borrower's monthly payment and total interest paid over the life of the loan, but requires the borrower to stay in the home long enough (known as the "break-even point") to recoup the initial fee, making it best for long-term homeowners.
Lender Competition & Costs
Different lenders have varying
operational costs, risk tolerances, and business strategies, which is why borrowers
shop around, going to multiple lenders to find the best available rate. Lender
competition and costs significantly influence mortgage rates. As a feature of
market action, more competition among lenders generally pushes rates down as
the lenders fight for business, while higher lender operating costs (such as overhead,
marketing, salaries) or lower risk tolerance often lead to higher rates, Thus, lenders
balance these factors, sometimes raising rates when busy or lowering them when
slow, frequently trading slightly higher rates for lower fees or vice versa,
impacting the borrower's total cost.
This article, Explaining Interest Rates To Borrowers, published on January 22, 2026, is authored by Jonathan Foxx, PhD, MBA, the Chairman & Managing Director of Lenders Compliance Group, the first and only full-service, mortgage risk management firm in the United States, specializing exclusively in residential mortgage compliance.
