One question we field as often as any is “What determines lending rates?” The short answer is that many factors – seen and unseen – go into the lending rates borrowers are quoted.

That said, a few factors are more impacting than others. The Federal Reserve is an obvious factor. When the Fed purchases long-term Treasury securities and mortgage-backed securities, it creates demand. Increased Fed demand, in turn, means lenders can offer loans at lower rates than if there was no Fed demand. The Fed, in a sense, creates a market.

The level of risk acceptance or aversion among investors also influences lending rates. When investors are more risk averse, as they have been for the past month, they flock to haven securities – Treasury notes and bonds and other high-quality, low-yield debt. This “flight to safety” pushes mortgage lending rates lower because investors are more willing to lend at lower rates because of demand for higher-quality securities.

The dynamic interaction of supply and demand also works on lending rates. If demand for borrowable funds is brisk, lenders are in a position to quote rates or charge points higher than the national average. If the supply of loan able funds increases, as it's prone to do when investors are more risk accepting, lending rates will drop to entice people to borrow. 

But perhaps the greatest influencing factor is anticipation – each individual's outlook on the market. If more individual lenders believe economic growth and inflation are in the future, rates will rise today in anticipation. The reverse will occur if more lenders see slower growth and lower inflation.

Anticipation also happens to be the most difficult (if not impossible) factor to quantify. What's more, anticipation can be very fickle and can change on a dime; thus making prognosticating very difficult.

Courtesy of Jessica Regan.

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