Just what exactly goes into a mortgage rate? Chances are most people don't really know or care -- as long as the price is right.

With the old days of mortgage banking gone, however, it's more important than ever for people to understand that rates no longer move according to the whims of some loan officer upstairs. The so-called "secondary market" -- where mortgages are bundled together and traded as single securities -- rules in the 1990s, and it is the ultimate force that guides rates up or down.

Here, in a nutshell, is how it works:

Investors call the shots
"Right now, we're lending a 30-year fixed at around 6.75 [percent]," says Jeff Rousseau, senior vice president for mortgage banking at Hibernia Corp. of New Orleans. "In determining those rates, I have a screen from Wall Street that shows me what securities would trade for.

"It's based upon what the investor requires."

The key to understanding the process lies in understanding the way a mortgage dollar makes its way through the system.

Banks do the numbers
For starters, consider how a bank gets its money. There are plenty of avenues, including overnight loans from Federal Reserve banks and fees charged to depositors. The price of those sources determines the bank's "cost of funds." From that base, a bank will extend loans at various rates that allow for a reasonable "spread," or profit margin.

When it comes to mortgages, however, lenders typically sell the loans that they make into the secondary market. That means they don't calculate borrowers' rates by simply adding a margin to their costs. Instead, they look at what secondary buyers are willing to pay, and set rates that are high enough to provide a profit for both lender and secondary buyer.

The secondary market
The secondary market works in the following way: Individual investors want to own mutual funds that earn them a decent amount of money. They buy these funds from companies that want to balance the stock portion of their portfolios with bonds, which are generally lower risk. Those companies turn to sellers of such securities, including Wall Street investment firms like Merrill Lynch & Co., in order to beef up their holdings.

Merrill Lynch and the others, in turn, want to offer something that promises higher yields than Treasuries but provides steady income. As a result, many turn to "mortgage-backed securities" -- debt instruments that consist of several loans bundled together and that are designed to yield income for years in the form of monthly mortgage payments.

In order to make the process work, however, fund managers and the like require some sort of guarantee that the loans are up to proper credit standards and other underwriting guidelines. For that assurance, they often require that lenders deal with the Federal Home Loan Mortgage Corp. or the Federal National Mortgage Association, commonly referred to as Freddie Mac and Fannie Mae. These quasi-governmental corporations will either buy a lender's loan and bundle it with others, or review the loan to make sure it conforms with their standards, and give it a passing grade.

"What's so cool about it -- the role of Fannie and Freddie -- is they've taken that mortgage from all these different little cities, and once they've put that stamp of approval on it, then they've made that where any investor in the country can buy a mortgage-backed security backed by any loan in the country," says Denis St. Marie, president of KeyCorp.'s mortgage services unit. "The whole role of Fannie and Freddie is to spread out the money."

Profits divided
Each party profits by taking a cut along the way. Say a 30-year-fixed mortgage was issued to a borrower at 7 percent. The lender would either sell the loan to Fannie Mae or Freddie Mac at 6.75 percent, or obtain one of the agency's guarantees. The 0.25 percent difference would be the lender's fee for collecting payments and otherwise "servicing" the loan.

Fannie Mae or Freddie Mac, meanwhile, would take 0.25 percent for guaranteeing the loan, or for packaging it with others and selling it to an investment company. That would leave the investor with a security that returns 6.50 percent.

Estimating your cost
So how does a borrower get an accurate estimate of what the mortgage will cost?

Most experts say that mortgage rates follow Treasury yields, and they do tend to move in tandem. But those yields have no direct impact on mortgage rates. Instead, people should look at the 30-day and 60-day commitment rates found in the money rates section of a newspaper's financial pages.

Without getting too technical, those rates are the net yields required by Fannie Mae and Freddie Mac. That means lenders must deliver loans to the agencies at those rates in order to be fully reimbursed, says Dorian Bomberger, a trader in Freddie Mac's mortgage finance department. The time frame is the number of days the lender has to finish the transaction.

By adding 0.25 percent for the lender's servicing fee to these commitment rates, customers arrive at a much more accurate retail rate forecast than they would get by scanning Treasury yields.