How Mortgage Interest Rates Are Determined in 2025: What Homebuyers Need to Know

Understanding how mortgage interest rates are determined is one of the most important steps in preparing to buy a home. 

Interest rates don’t just affect your monthly payment; they influence the total cost of your home over decades.

Whether you’re a first-time buyer or considering refinancing, this 2025 guide breaks down how mortgage interest rates work, what influences them and how you can take control.

What affects your mortgage interest rate?

Interest rates are shaped by two broad categories:

1. Personal factors: Items unique to your financial profile and the property you’re buying
2. Market factors: Economic trends, government policies and investor behavior

Let’s explore both in greater detail.

Personal factors on interest rates that you can control

Your personal financial health plays a major role in the interest rate a lender will offer you. 

Here’s what matters most:

Credit score

Your credit score reflects your history of managing debt. Higher scores generally qualify you for lower mortgage interest rates.

• Excellent (740+): May access the lowest rates available
• Good (700–739): Still competitive, with slightly higher rates
• Fair (620–699): Eligible for loans, but likely with higher rates and stricter terms
• Poor (less than 620): May need to explore FHA or other government-backed loans

Lenders evaluate credit to assess the likelihood you’ll make timely payments. 

While no single score guarantees approval, improving your credit score before applying can save thousands over the life of your loan. This might involve paying down credit card balances, avoiding new debt and correcting any errors on your credit reports.

Down payment and loan-to-value ratio (LTV)

The more money you put down, the less risk for the lender. A larger down payment lowers your loan-to-value ratio, often leading to better interest rates.

• LTV less than 80%: Ideal for best rates
• LTV 80–90%: May require mortgage insurance
• LTV greater than 90%: Higher risk and rates, especially without insurance

For example, if you’re buying a $300,000 home and putting down $30,000, your LTV is 90%. 

Lenders prefer lower LTVs because they represent a greater borrower investment and a lower chance of default.

Occupancy type

Lenders offer the best rates for primary residences. Rates for second homes or investment properties are typically higher because they carry more risk. 

If financial difficulties arise, borrowers are more likely to prioritize the mortgage on their primary residence.

Loan amount and cash-out refinances

Taking cash out (with a larger loan than you currently owe) may increase your interest rate. That’s because lenders see a cash-out refinance as a higher lending risk compared to standard refis or purchase loans. 

Cash-out refinances are often used to consolidate debt or fund home renovations, but the added loan amount increases your LTV and the perceived lending risk.

Market factors outside your control

Mortgage rates also fluctuate based on national and global financial conditions. 

Here are the most important:

Federal Reserve decisions

The Federal Reserve (“the Fed”) does not directly set mortgage rates, but its actions influence them. 

When the Fed adjusts the federal funds rate (the rate at which banks lend to each other), mortgage rates often follow suit.

• Rising fed rates = Higher mortgage rates
• Falling fed rates = Lower mortgage rates

In 2025, the Fed continues to use interest rate policy to balance inflation and employment. Monitoring their announcements can help borrowers anticipate market changes.

Inflation trends

When inflation is high, lenders require higher interest rates to preserve their returns. Mortgage rates generally rise with inflation and fall when inflation cools.

For instance, if the cost of goods and services is increasing quickly, the purchasing power of future loan repayments diminishes. Higher mortgage rates compensate for this loss.

Economic indicators

Mortgage lenders watch economic data like employment, GDP growth and consumer spending. A strong economy usually pushes rates higher, while a weak one may cause rates to drop.

If unemployment rises or consumer confidence drops, lenders may lower rates to stimulate borrowing and support housing demand.

Bond market and mortgage-backed securities

Most mortgages are sold to investors as part of mortgage-backed securities (MBS). When demand for MBS is high, mortgage rates can drop. When demand falls, rates tend to rise.

Investors tend to seek safety in MBS during times of stock market volatility. When this demand increases, it pushes yields down, which in turn lowers mortgage rates.

Treasury yields (Constant Maturity Treasury Rates)

Adjustable-rate mortgages (ARMs) are often tied to financial indexes like the 1-Year Constant Maturity Treasury (CMT) rate. These indexes reflect investor expectations and can affect rates month to month.

Even for fixed-rate mortgages, Treasury yields offer a benchmark that influences pricing trends. Tracking the 10-year Treasury note is one way to forecast potential mortgage rate direction.

Secured Overnight Financing Rate (SOFR)

SOFR is a benchmark interest rate based on overnight transactions secured by U.S. Treasury securities. It’s increasingly used in setting rates for ARMs and other variable-rate products.

Replacing the older LIBOR (London Interbank Offered Rate) benchmark, SOFR is considered more reliable and transparent. Borrowers with ARMs should pay attention to how their lenders incorporate SOFR into their loan agreements.

How to get a better mortgage interest rate

While you can’t control inflation or the bond market, you can improve your personal financial profile.

Smart strategies to help your mortgage interest rate include:

• Raise your credit score: Pay off debt, avoid new credit inquiries and correct errors on your credit report.
• Save for a larger down payment: Even an extra 5% can significantly improve your loan terms.
• Reduce other debts: A lower debt-to-income ratio (DTI) makes you a more appealing borrower.
• Choose the right loan program: FHA, VA or USDA loans might offer lower rates depending on your profile.
• Lock your rate early: Especially in a rising-rate environment, rate locks can shield you from sudden changes.
• Get Committed®: Compass Mortgage’s Get Committed® program offers a fully underwritten loan commitment and interest rate lock even before you make an offer, giving you stronger buying power in competitive markets.

Why do rates vary by lender?

Even on the same day, different lenders may quote different rates because they each have unique risk models, overhead costs and investor expectations. That’s why it’s essential to compare offers.

Lenders also offer varying options for rate locks, discount points and closing costs—all of which affect your effective rate. 

Comparing at least three lenders can help you find the most favorable terms for your situation.

Bottom line: Mortgage interest rates are dynamic

Rates aren’t random; they’re influenced by your credit profile, the size of your loan, the property type and the state of the economy. Understanding how they work puts you in a stronger position to secure a great mortgage.

Lock in your rate with Compass Mortgage’s Get Committed® program for peace of mind in a shifting market. That’s one less thing to worry about during this exciting new chapter of your life.

Apply with Compass Mortgage today or call us at (877) 635-9795 to speak with one of our experienced loan officers.