How do mortgage lenders make money?

Mortgage lenders can be paid in many ways. When home buyers educate themselves on these methods, they may be able to save thousands of dollars in mortgage loans.

Key points

  • Mortgage lenders can make money in a variety of ways, including origination fees, yield premiums, discount points, transaction costs, mortgage-backed securities, and loan services.
  • The closing costs that lenders can profit from include application, processing, underwriting, loan lock-in, and other fees.
  • The yield differential includes the difference between the interest rate the lender pays to borrow from a large bank and the interest rate charged to the borrower.
  • Mortgage-backed securities allow lenders to make a profit by packaging and selling loans. Lenders can also provide services for their packaged and sold loans through MBS.

Starting fee

Since lenders use their funds when extending the mortgage, they usually charge an origination fee of 0.5% to 1% of the loan value, which is due when the mortgage is paid. This fee increases the total interest rate (also known as the annual interest rate (APR)) of the mortgage and the total cost of the house. APR is the mortgage interest rate plus other fees

For example, a loan of 200,000 USD has an interest rate of 4%, a maturity of 30 years, and an initial fee of 2%. Therefore, the initial cost for the buyer is $4,000. If the homeowner decides to pay the initial fee at the same time as the loan amount, this will effectively increase their interest rate, calculated as APR.

The monthly mortgage payment is 6% of 200,000 USD, which is 954 USD. However, when the $4,000 origination fee is added and allocated to the 30-year loan, the monthly payment increases by $19, and the total monthly payment is $973.

Yield differential premium

Mortgage lenders use depositors’ funds or borrow money from larger banks at lower interest rates to extend loans. The difference between the interest rate the lender charges the homeowner to extend the mortgage and the interest rate the lender pays to replace the borrowed funds is the yield spread premium (YSP). For example, the lender borrows funds at 4% interest and extends the mortgage loan at 6% interest to obtain 2% loan interest.

Discount points

Some loans, called discount points, may expire at the end to help lower mortgage interest rates. A discount point is equal to 1% of the mortgage amount and can reduce the loan amount by 0.125% to 0.25%. For example, two points on a $200,000 mortgage loan are 2% of the loan amount, or $4,000.

Prepayment of points usually reduces the monthly repayment amount, thereby saving the homeowner money during the loan period. The degree of interest rate reduction depends on the selected lender, mortgage type and market conditions. Homebuyers should make sure to let the lender explain how the payment discount point affects mortgage interest rates.

Checkout cost

In addition to loan origination fees, lenders also have to pay application fees, processing fees, underwriting fees, loan lock-in fees, and other fees during the closure period. Since these closing costs may vary from lender to lender, these costs are pre-explained in the Good Faith Estimate (GFE).

Before deciding on a mortgage, home buyers should carefully read the fee list and talk to the lender to determine whether the home buyer can negotiate certain fees or save money by doing business with other lenders.

Mortgage-backed securities

After completing different types of mortgage loans, the lender will combine loans with different profit levels into mortgage-backed securities (MBS) and sell them for profit. This frees up funds for lenders to extend additional mortgages and earn more income. Pension funds, insurance companies, and other institutional investors purchase MBS to obtain long-term benefits.

The sale of mortgage-backed securities can free up funds to make additional loans.

Loan service

Lenders can continue to earn income by providing services for the loans contained in the MBS they sell. If the MBS purchaser is unable to process mortgage payments and handle management tasks involving loan services, the lender may perform these tasks at a fraction of the mortgage value or a predetermined fee.

Bottom line

Since home buyers face huge costs when obtaining mortgages, they must understand how mortgage lenders get paid and make money. When home buyers educate themselves on this process, they are more likely to save thousands of dollars on mortgages and feel safer about the purchase.

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