What Is a Mortgage?

A mortgage is simply a loan used to purchase a home. When you don’t have (or don’t want to spend) all the cash to buy a home upfront, you borrow the funds from a lender. In return, you agree to repay the loan—plus interest—over time. Just like with car financing, if the borrower doesn’t uphold their end of the agreement, the lender can repossess the asset—in this case, your home. Thankfully, that doesn’t happen when payments are made as agreed!

Key Takeaways

• A mortgage is a type of financing used specifically to buy a home.
• You own the property while you’re paying back the loan.
• If you don’t make your payments, the lender can ultimately take the property back.

Why Lenders Charge Interest

Lenders don’t simply hand out money as a favor. Their profit primarily comes from the interest charged on the loan amount. In everyday terms, interest is the extra amount (beyond the original balance, or “principal”) you pay in exchange for borrowing money. That’s why mortgage interest rates matter so much—because they’re the driving force behind your monthly payment and the total cost of borrowing over the life of the loan. The core concept is straightforward: the lender earns a profit based on what you pay over time or upfront (or a bit of both).

The Basics: Principal, Interest, and Mortgage Rates

Principal

Principal refers to the amount you owe on your loan at any given time. If you buy a home for $200,000 and make a $10,000 down payment, your principal starts at $190,000. Over time, as you make your monthly payments, the principal balance goes down.

Payoff vs. Principal

You might notice if you’ve refinanced or sold a home before, your payoff is a bit higher than your principal balance. That extra bit is typically unpaid interest for the portion of the month since your last mortgage payment.

Interest Rate vs. Effective Rate

When people say “mortgage rates,” they’re usually talking about the note rate—the official interest rate applied to your principal. However, there’s also an effective rate that factors in any upfront costs you’ve paid to the lender (often called points or discount points).

APR (Annual Percentage Rate)

To standardize the way lenders disclose these “effective rates,” the law requires them to calculate an APR, which attempts to blend in certain lender fees. APR can be helpful, but it’s not always a perfect apples-to-apples comparison between different lenders because each lender may calculate fees a bit differently.

Upfront Costs vs. Cost Over Time

Points (or Discount Points)

Points are an upfront payment you can choose to make in order to secure a lower note rate. Imagine you have two scenarios:

• Scenario A
  • Upfront costs: $5,000
  • Monthly payment: $2,000
• Scenario B
  • Upfront costs: $6,200
  • Monthly payment: $1,986

That extra $1,200 upfront in Scenario B saves you $14/month on your payment. To figure out your “break-even” on that $1,200, you’d divide $1,200 by $14, which equals about 86 months (just over 7 years). If you’re likely to keep your mortgage longer than that—and if you don’t have a better place to invest your cash—it may be worth buying down the rate. If you might move or refinance sooner, then you might skip paying points. There’s no absolute right or wrong: it’s simply a choice between paying more now or paying more over time.

Rolling in Closing Costs

Sometimes, instead of raising your interest rate to reduce upfront costs, you can roll part of your closing costs into the loan balance. This slightly increases your total loan amount (and your monthly payment). Whether or not this is a good option depends on how the math shakes out compared to the next available interest rate and your personal financial situation.

What Is an APR—and Why Isn’t It Perfect?

APR attempts to factor in certain upfront charges (called prepaid finance charges, or PFCs) so you can see the overall cost of financing in a single number. For instance, homeowner’s insurance isn’t a PFC because you’d have insurance whether or not you had a mortgage. But a lender-specific “processing fee” might be.

Here’s the catch: while lenders are all required to disclose an APR, they don’t always do it the same way. Some lenders are more conservative, including a range of fees in their APR calculation. Others might categorize fees differently, resulting in a more favorable-looking APR on paper. Ultimately, APR can be a useful tool, but it’s not bulletproof for comparing quotes. The best approach is to look closely at each line of your estimated closing costs and ask questions if something seems off.

How Mortgage Rates Are Determined

Mortgage rates reflect more than just your personal financial situation. Yes, your credit score, property type, program, and down payment all play a role. But broader market forces are at work, too.

Bond Market Basics

Much like how the government borrows money by issuing bonds (like U.S. Treasuries), mortgage-backed securities (MBS) are created when lenders bundle groups of mortgages to sell to investors. Investors pay upfront for the right to collect the interest from those mortgages, and that influx of cash allows lenders to make more loans.

Because of this “bundle and sell” process, rates depend heavily on the market’s appetite for mortgage-backed securities. If investors flock to MBS, their price goes up, and mortgage rates generally move down (and vice versa).

Operational Factors at Individual Lenders

On a smaller scale, lenders also set rates based on their own capacity. If they’re overloaded with loan applications, they might nudge rates higher to slow new applications. If they want more business, they might lower rates a bit to be more appealing. That’s why you may see different lenders offering slightly different rate quotes on the same day—they each have their own cost structure, staff capacity, and risk appetite.

Why Mortgage Rates Change

Mortgage rates can change daily—or even multiple times a day—if the bond market is volatile. Think about it as if you were shopping for produce: if the price of oranges shoots up in the morning, grocery stores might adjust their shelf prices by afternoon. It’s not random; it’s based on investor demand, supply issues, and economic news.

Common market-moving factors include:

• Economic data (unemployment, inflation, consumer spending)
• Federal Reserve announcements (though the Fed doesn’t set mortgage rates directly, its policies impact bond markets)
• Global events (political tensions, pandemics, etc.) that drive investor sentiment
• Supply and demand in the MBS market

Locking Your Mortgage Rate

Eventually, you’ll need to “lock” your rate. This is an agreement with your lender that guarantees a certain note rate for a specified period of time—often 30, 45, or 60 days. If you close your loan within that “lock window,” the lender honors the agreed-upon rate even if the market changes.

Lock Time Frames

Longer locks typically cost more (either as a slight increase in rate or an additional upfront fee). That’s because the lender is assuming a greater risk of market fluctuations over a longer period.

When to Lock

There’s no perfect answer to “Should I lock today or wait?” The safest route is to lock sooner if you’re happy with the monthly payment and costs. Waiting can pay off if rates move down, but it can also backfire if rates spike and you can no longer qualify—or if you simply end up paying more.

Lock Extensions

If your loan doesn’t close in time, many lenders allow you to extend your lock for a fee. In some cases, if rates have jumped significantly since you first locked, the new cost can be much higher. Having realistic timelines and quick communication with your loan team can help you avoid big surprises at the end.

Securitization: Turning Mortgages into Bonds

For a deeper understanding: when investors worry about whether a mortgage might get paid off early (due to a refinance, sale, or foreclosure), they price that risk into what they’ll pay for a particular group of mortgages. Securitization helps spread that risk across many loans, just like mixing produce from multiple farms ensures a consistent supply and price—one bad crop won’t spoil the entire batch.

Why This Matters for Your Rate

The more uniform and predictable mortgages are, the more comfortable investors feel—and the less they need to charge in return. This is one reason why most mortgages follow certain guidelines (such as those set by Fannie Mae or Freddie Mac). Investors like consistency, so that’s exactly what the mortgage industry provides. The benefit to you? Generally, more stable and more competitive rates.

Final Thoughts: Putting It All Together

A Three-Way Equation: You, the Lender, and the Investor

• You need a loan (demand for financing).
• The Lender facilitates that loan and handles day-to-day operations.
• Investors buy rights to mortgages, channeling the money back into the system.

When investors purchase mortgage-backed securities, they’re looking for a return that makes sense compared to other bonds (like U.S. Treasuries). That’s why mortgage rates often move in tandem with the broader bond market.

Why Different Lenders Quote Different Rates

All lenders work with the same broad “raw materials” (the bond market). However, each has different overhead, profit margins, staff capacity, and levels of efficiency. This means quotes can—and do—vary. Some lenders also include more third-party costs in their estimates than others, so always look at the lender’s fees and not just the bottom line if you’re shopping around.

What Matters Most to You

• Costs vs. Service: A rock-bottom rate can come with minimal hands-on support. On the other hand, you might prefer a slightly higher rate if it means more personalized service.
• Upfront Costs vs. Ongoing Payments: Will you pay points now to lower your monthly payment? Or keep costs down upfront and pay a bit more month to month?
• Lock Timing: If a sudden rate spike could jeopardize your ability to qualify, locking sooner might be safest.

Your Mortgage Journey

Ultimately, the mortgage process is about finding a balance that works for you—one that fits your budget, your long-term plans, and your comfort level with risk. Mortgage rates aren’t one-size-fits-all, and they’re influenced by market forces that can shift daily.

Feel free to reach out if you’d like a personalized conversation about your finances and goals. Our team is here to help you understand the details, explore your options, and find a mortgage strategy that aligns with your life. By knowing the basics of how rates work, you’ll be better equipped to make informed decisions every step of the way.

Ready to Talk About Your Own Rate?

Have questions about your unique situation or just want to run some “what-if” scenarios? Get in touch with us today. We love nothing more than helping you feel confident and educated as you move toward homeownership (or your next home purchase). Let’s navigate the world of mortgage rates together!