How lenders set mortgage rates

You can't automatically blame your mortgage lender if the rate you're offered stinks.

You see, your lender has little say in what rate you're charged these days. There's no Mr. Potter behind the counter trying to figure out how to swindle you out of your hard-earned loot. And even huge banking conglomerates like Citigroup Inc. and Wells Fargo & Co. answer to a higher mortgage rate power -- namely, the secondary market.

The secondary market is where Fannie Mae, Freddie Mac and other mortgage investors ply their trade. These huge agencies -- which were founded with government help decades ago to make the mortgage lending process more efficient -- purchase loans that lenders make, then either hold them in their portfolios or bundle them with other loans into mortgage-backed securities. Those securities get sold to mutual funds, Wall Street firms and other financial investors who trade them the same way they trade Treasury securities and other bonds.

As a result of this business model, investors -- rather than bankers or mortgage brokers -- are in the driver's seat when it comes to setting mortgage rates. Whenever economic news suggests the economy is heating up too much, these investors demand higher yields from lenders. That's because they don't want to buy low-yield bonds now if Federal Reserve Board rate hikes (designed to cool the economy down) are going to make higher-yield bonds available later. The only way lenders can get their loans sold in this environment is to raise the yields they offer investors. This drives the rates they charge to consumers higher.

The same thing happens in reverse when it looks like the economy is degenerating. Investors start clamoring for bonds because they figure the Fed will have to cut rates in the future (to get the economy going again) and if they wait, they'll end up with lower-yielding bonds. Since investor demand is so strong, the lenders who control loan supply can offer lower yields. This results in lower rates for consumers.

Because of this process, borrowers who truly want to get the best rates have to pay more attention to financial news than ever before.