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.
Because lenders use their own funds when extending mortgages, they typically charge an origination fee of 0.5% to 1% of a loan value, which is due with mortgage payments. This fee increases the overall interest rate paid on a mortgage and the total cost of the home. For example, a $200,000 loan with a 6% interest rate over 30 years has a 2% origination fee. The homebuyer pays the origination fee of $4,000, along with other applicable fees, when closing on the loan. The monthly mortgage payment, 6% of $200,000, is $1,199. However, when adding in the origination fee of $4,000 and dividing it out over the 30-year loan, the payments increase by $11.11 per month for a total monthly payment of $1,210. Overall, the homeowner pays an 8% interest rate rather than the perceived 6% rate. The higher interest rate results in more of the homeowner's money going toward the mortgage and significantly increasing the overall cost of the loan.
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 0.125% to 0.25%. For example, two points on a $200,000 mortgage is 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. 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.
Mortgage Backed Securities
After closing on different types of mortgages, lenders group together loans of varying profit levels into mortgage backed securities (MBS) 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.
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, it is important they understand how mortgage lenders get paid and make money. When a homebuyer educates himself on the process, he is more likely to save thousands of dollars on his mortgage and feel more secure about the purchase.