How the Lenders Decide Your Interest Rate

Your lenders set their rates based on the Federal Funds Rate, which is set by the Federal Reserve Board as a way of regulating the economy. This is the major determining factor that the lender uses to decide what current mortgage rate to set; however, it is not the only factor.

Depending on the economy and the overall demand for mortgages, any given lender may narrow its own margins in an effort to stay competitive and attract more business. Most often lenders will opt to do this during downturns in the economy and the housing market.

The Federal Housing Finance Board (FHFB) publishes an index, which shows a figure for current mortgage rates in America. However, this rate is made up of an average of rates charged by all lending institutions. Unlike the Federal Reserve Board’s Federal Funds Rate, which is set by the Fed as a way to regulate the economy, the FHFB’s index rate is merely an indicator. Some lenders, however, does opt to use this index rate as a guideline when setting their own current mortgage rate. As of November 30, 2004, the FHFB index rate was 5.64 percent.

Some lenders may have rates significantly higher than the national average, or FHFB index rate; for example, a nonprime lender may peg its own mortgage rates at several percent higher than this index. A nonprime lender might, for example, take a monthly index rate of 5.64, add six percent to it, and establish its own current mortgage rate at 11.64 percent.

A nonprime lender usually takes significantly more leeway in setting its mortgage rates than a conventional lender, since market forces demand that the conventional lender offer rates that are competitive with the national average.

A nonprime lender is under no such competitive pressure, since it is offering loans to individuals who would not qualify for a mortgage from a conventional lender at the FHFB’s current index rate.