Mortgage lenders may get paid in multiple ways. When homebuyers educate themselves on these methods, they may be able to save thousands of dollars on their mortgage.
- Mortgage lenders can make money in a variety of ways, including origination fees, yield spread premiums, discount points, closing costs, mortgage-backed securities (MBS), and loan servicing.
- Closing costs fees that lenders may make money from include application, processing, underwriting, loan lock, and other fees.
- Yield spreads include the spread of the rate that a lender pays for money they borrow from larger banks and the rate they charge borrowers.
- Mortgage-backed securities allow lenders to profit by packaging and selling loans. Lenders may also get money for servicing the loans they package and sell via MBS.
Because lenders use their funds when extending mortgages, they typically charge an origination fee of 0.5% to 1% of the loan value, which is due with mortgage payments. This fee increases the overall interest rate paid—also known as the annual percentage rate (APR)—on a mortgage and the total cost of the home. The APR is the mortgage interest rate plus other charges.
For example, a $200,000 loan with a 4% interest rate over 30 years has a 2% origination fee. Thus, the homebuyer origination fee is $4,000. If the homeowner decides to finance the origination fee along with the loan amount, this will effectively increase their interest rate, calculated as the APR.
The monthly mortgage payment, 6% of $200,000, is $954. However, when adding in the origination fee of $4,000 and dividing it out over the 30-year loan, the payments increase by $19 per month for a total monthly payment of $973. The interest is 6%, which incorporates the lender borrowing the funds at 4% interest and extending a mortgage at 6% interest, meaning the lender earns 2% in interest on the loan. This is called the Yield Spread Premium.
Yield Spread Premium
Mortgage lenders use funds from their depositors or borrow money from larger banks at lower interest rates to extend loans. The difference between the interest rate that the lender charges homeowners for extending a mortgage and the rate the lender pays for replacing the money borrowed is the yield spread premium (YSP). For example, the lender borrows funds at 4% interest and extends a mortgage at 6% interest, earning 2% in interest on the loan.
Part of the loan, known as a discount point, may be due at closing to help buy down the mortgage’s interest rate. One discount point equals 1% of the mortgage amount and may reduce the loan amount by 0.125% to 0.25%. For example, two points on a $200,000 mortgage are 2% of the loan amount, or $4,000.
Paying points upfront typically lowers monthly loan payments, which saves homeowners money over the life of the loan. The extent to which the interest rate is lowered depends on the chosen lender, type of mortgage, and market conditions. Homebuyers should be sure to have lenders explain how paying discount points impacts the interest rate on their mortgage.
In addition to the loan origination fee, an application fee, processing fee, underwriting fee, loan lock fee, and other fees charged by lenders are paid during closing. Because these closing costs may vary by lender, the fees are explained upfront in the good faith estimate (GFE).
Homebuyers should carefully read the list of fees and talk with the lender before deciding on a mortgage to determine whether the homebuyer may negotiate certain charges or save money by doing business with another lender.
After closing on different types of mortgages, lenders will group loans of varying profit levels into mortgage-backed securities and sell them for a profit. This frees up money for the lenders to extend additional mortgages and earn more income. Pension funds, insurance companies, and other institutional investors purchase the MBS for long-term income.
Selling mortgage-backed securities can free up capital to make additional loans.
Lenders may continue to earn revenue by servicing the loans contained in the MBS they sell. If the MBS purchasers are unable to process mortgage payments and handle administrative tasks involved with loan servicing, the lenders may perform those tasks for a small percentage of the mortgage value or a predetermined fee.
The Bottom Line
Because homebuyers face substantial expenses when securing a mortgage, they must understand how mortgage lenders get paid and make money. When a homebuyer educates themselves on the process, they are more likely to save thousands of dollars on their mortgage and feel more secure about the purchase.