Mortgage lending is a complex industry that consists of lenders, investors, and borrowers. Many homeowners don’t even know what goes on behind the scenes before, during, or after they get their money. Instead, they’re just happy to be able to afford a home loan and pay it back every month. Of course, mortgage finance has many aspects, and regular borrowers may have questions about how they work, lender requirements, and how much home they can afford.
One thing many borrowers don’t consider is where lenders get the money to fund the loans. Mortgage lenders give loans worth hundreds of thousands of dollars to borrowers every single day, and they don’t keep this money on hand to fund those loans either. Instead, funding a loan is a complex process with an extensive network of lenders, investors, banks, and other parties.
How Does a Mortgage Get Funded?
The money used to fund a mortgage goes through a lengthy process before the approved borrower sees it. Some lenders have cash reserves they use to fund loans, while others borrow money. Ultimately, there’s a secondary mortgage market that provides lenders with the funds they need to generate mortgage loans. In this market, lenders purchase loans from other lenders and package and sell mortgages to investors in the secondary market.
For example, a borrower submits a mortgage loan application, which is reviewed and approved by the lender. To get the money for the loan, the lender can draw from its own cash reserves or take a warehouse line of credit and pay the warehouse lender back when it sells the mortgage loan in the secondary market.
Ultimately, borrowers don’t have to worry about the second market at all, but they may notice when a different lender or company starts sending them their mortgage bills. Mortgages are bought and sold every day by other companies, and it doesn’t affect how much borrowers pay since their interest rates are locked in from the beginning of the loan. However, mortgage lenders and other institutions can earn more money by selling mortgages and trading them on the secondary market.
How Do Mortgage Lenders Make Money?
Earlier, we talked about how some mortgage lenders might have cash reserves they use to fund at least some of the mortgage loans they give. Mortgage lenders make money in a few different ways, including:
Origination Fees
When you get a mortgage loan, you pay origination fees that are up to 1% of the loan value. These fees are due along with your monthly mortgage payments, and most borrowers don’t even notice them. However, the origination fee increases the interest rate (APR) on a mortgage based on the total cost of the home. Borrowers can choose to finance the origination fee with the loan amount, but that will increase their interest rate, giving them a higher monthly payment.
Discount Points
Discount points are part of the mortgage loan, and they’re typically due at the time of closing to help reduce interest rates. One point equals 1% of the mortgage amount and can reduce the total loan amount. Paying points upfront benefits borrowers because it means a less expensive loan, but it also pays lenders right away, adding to their cash reserves.
Yield Spread Premium
Mortgage lenders may borrow money from banks at low-interest rates to give loans to borrowers. The difference between their interest rate and the one charged to homeowners and the rate they pay for replacing that money is called the yield spread premium (YSP).
Closing Costs
Lenders also make money from closing costs and other various fees they charge throughout the mortgage application process. Closing costs typically vary by lender, so those fees should be explained in the estimate you get upfront after applying.
Securities
Mortgage-backed securities are when lenders group loans of different profit levels together and sell them for a profit to free up more money and give out more loans, ultimately earning them more revenue. Pension funds, insurance companies, and other investors can purchase these securities as part of their investment portfolios and also earn an income.
Servicing Loans
Lenders earn revenue by serving loans after selling securities. If the mortgage-backed security investors can’t process the payments themselves or handle administrative tasks, the previous lender may choose to do loan serving for a fee, allowing them to process the funds.
Wrapping Up
While some lenders have cash reserves they use for loans, many don’t keep that kind of money on hand because it doesn’t allow them to fund as many mortgages. So instead, most lenders work with the three major institutions Fannie Mae, Freddie Mac, and Ginnie Mae.
The company you pay your monthly mortgage payments to may not be the one that actually owns your loan. Instead, they might just be the ones servicing the loan and taking a small percentage for a fee when other institutions like Fannie Mae or groups of investors own the loan.
In most cases, your mortgage loan is pooled with other loans and sold off, but a mortgage lender might continue to service the loan in return for a small fee. Many companies service billions of dollars worth of mortgage loans instead of actually owning the loans themselves. Once your loan is sold in a pool, the lender continues to make money through other methods like origination and closing fees.
So, if you ever thought your mortgage loan was owned by the company that sends you the bill, you’re probably wrong. Of course, you can always ask your lender how it works if you’re interested, but your bill will stay the same no matter what. In most cases, borrowers don’t need to know where their money came from or where it’s going, but it does raise some interesting questions about how loans are funded and serviced. If you’ve ever wondered why the company name on your mortgage bill keeps changing, your loan is likely continuing to be sold to different companies or serviced by different lenders.
Ashley Nielsen
Ashley Nielsen earned a B.S. degree in Business Administration Marketing at Point Loma Nazarene University. She is a freelance writer where she shares knowledge about general business, marketing, lifestyle, wellness or financial tips. During her free time she enjoys being outside, staying active, reading a book, or diving deep into her favorite music.
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