After pouring over the mortgage rates posted all over the internet, after shopping around to the local banks and mortgage brokers, after watching the economy plunge the housing market into free fall, any potential home-buyer must wonder who or what determines how the interest rates are set. The effect a credit score has on a loan approval almost seems secondary compared to understanding how the big ‘interest’ game is played, and how it ‘trickles down’ to the everyday consumer’s ability to find a decent place to live, and the means to afford it.
It turns out, the lender or broker has little to do with how the mortgage interest rates are determined. They simply control who finally gets a favorable nod, and on what terms. Mortgage interest rates are played out on a much bigger game board, and are primarily manipulated on what is known as the secondary market, where mortgages are bought and sold, much like a game of Monopoly.
Fannie, Freddie, and the Wizards of Wall Street
A few decades ago, the federal government sought to stabilize the mortgage lending process, and created two enormous mortgage investment entities called Fannie Mae and Freddie Mac. These monoliths, along with other mortgage investors, purchase the loans that the local lenders and brokers arrange, gather them into portfolios or wrap them up with other loans into things called mortgage backed securities. From there, these bundles are sold to Wall Street, mutual fund managers and other financial powerhouses, to be traded just like Treasury bonds, securities and other financial instruments. This process is what actually determines the interest rate a potential homeowner will pay to put a roof over their heads.
From that point, and just like the stock market, these securities are tied to the higher yields the investors demand when the economy is good, which pushes the local lenders to raise the local interest rates. When the markets take a dive, so do the interest rates, due to the higher demand from the investor side of the equation. And so it goes.