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Why Do Mortgage Rates Differ Between Counties?

By Arvin Sahakian · Mar 14, 2016 · Mortgage

Why Do Mortgage Rates Differ Between Counties?

Image courtesy of BeSmartee, Mortgages Across the USA

Mortgage rates differ from county to county primarily due to the risk an investor of a mortgage or a portfolio (of numerous mortgages) has to face and be willing to pay for. Because mortgage investment risk is relative and variable, so too are their interest rates.

Numerous factors come into play when the cost and rate of a mortgage is determined. The credit worthiness of a borrower is what most of us are accustomed to hearing about. Things like credit scores, debt-to-income ratio, and loan-to-value ratio are some of the most important considerations the loan officers and underwriters at a bank review in order to determine what pricing buckets you fall into, if any at all.

Think of your mortgage as a product being created on an assembly line. Most of the parts are similar to all other products produced, but there are slight nuances that make each product slightly unique from one another. It’s this uniqueness that determines the variable in the difference of the price a customer on the other end is willing to pay for that product.

Ultimately, when a lender gives you money for your mortgage, they want to make sure they can sell that mortgage to another bank or investor in the future, this way your original lender can free up capital in order to re-invest in other new mortgage borrowers.

So what determines the difference in mortgage rates from county to county? Primarily, it has to do with mortgage-backed securities, and stemming from that, it has to do with how much competition there is amongst banks, foreclosure laws, and differences in costs.

Mortgage Backed Securities

A mortgage-backed security is a type of bond representing an investment in a group, or pool, of real estate loans. A bank puts mortgage loans they lend to borrowers of similar types and credit quality into a pool. There may be hundreds or even thousands of loans in a single pool. The bank then sells the pool to a government agency, government sponsored-enterprise or private investment firm as a single bond called a mortgage-backed security.

It’s a lot more complicated than this, but simply put, it’s the variation in prices that the buyers of these mortgage-backed securities are willing to pay that determine the variation in mortgage rates from county to county and from state to state.

Investors in mortgage-backed securities consider various determinants and issue a premium that they add on top of a base interest rate, or risk-free interest rate. There are four major pricing premiums they add to a risk-free interest rate:

  1. Liquidity Premium - A premium that investors demand when and investment cannot be easily converted into cash at fair market value.
  2. Inflation Premium - A premium investors want to compensate for the loss in the value of their investment due to inflation.
  3. Maturity Premium - A premium where, all else being equal, a borrower’s mortgage obligation will be more sensitive to interest rate fluctuations the longer to maturity it is (Rates go down, customer may refinance).
  4. Default Risk Premium - A premium based on the chance that a borrower won't make payments on time, or will be unable to pay what is owed. The risk will be high or low depending on the creditworthiness of the borrower.

A mortgage investor will take the base (risk-free) rate, then add one or all of the premiums above to tell the bank selling the loans what they are willing to pay for it. Your bank will take this information, go back to their offices and make a determination on what they should offer customers on the retail side considering what their buyers are willing to pay.

risk of mortgage backed securities

Investor Risk of Mortgage Backed Securities


Now that we have the mortgage-backed securities gobbledygook out of the way, let’s get into explaining why rates differ based on competition.

Think of four banks in your city as retail clothing stores. All of these four stores sell the exact same clothing, carry the same sizes and buy their inventory at the same price from the same wholesaler. Then assume these stores have different names but the same color and size sign outside. How will they differentiate themselves and get you to shop with them versus the competitor? The answer is pricing and service. If one store lowers their price, and offers better service, you will be more likely to go with them versus their competitors. The other stores will become envious, and compete for your business.

It doesn’t work too differently with banks. If you live in a metropolis like Los Angeles, then you have dozens of banks all competing for your business. You will see that rates in metro areas like L.A. are lower than less densely populated areas.

Now assume that you live in a rural area or a state with a small population and very few banks. Because there is little competition, these banks will not be as aggressive in lowering their prices as would a bank in Los Angeles. Due to little competition, they feel they don’t need to compete on price.

Foreclosure Laws

There are 28 states in the country that don’t require a judicial process to foreclose on a delinquent mortgage. California is one of these states. This non-judicial method of foreclosing on property, due to the borrower was unable to make payments, is the least costly way for a lender to get the defaulted borrower out of the home based on current laws in these respective states.

The remaining 22 states in the country have a judicial process to foreclose on a property with a delinquent mortgage. Hawaii, New York, and Louisiana are among these states. Because a judicial foreclosure is an arduous and more costly process for the lenders in these states, they typically price loans in these areas higher to compensate for a potential mortgage delinquency in the future.

Costs Of Doing Business

I would say this determinant has the least effect on mortgage rates from those we have described above, but nevertheless, it is important to note because it does move the scale.

Certain states and counties are far more expensive for banks and lenders to do business in than others. For example, California is known to have high business taxes, and Hawaii and New York are known to have expensive real estate and rental costs. Ultimately, the more expensive and restrictive it is for a lender to do business, the more their customers are likely to see themselves paying higher prices for the same services than their neighboring states or counties.

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