How Banks Earn from Selling Newly-Issued Residential Mortgages
When banks sell newly-issued residential mortgages, they can earn money through several channels. The specific profit can vary based on factors such as the type of mortgage, market conditions, and the bank's business model. This article delves into the main ways banks make money from selling loans.
Origination Fees
Banks often charge fees for processing the loan application. These fees can range from 0.5% to 1% of the loan amount, and they are typically collected upfront. Origination fees are one of the primary sources of income for banks when selling a mortgage.
Interest Rate Spread
The bank may sell the mortgage at a higher interest rate than the rate it offers to the borrower. The difference, known as the interest rate spread, can provide ongoing income over the life of the loan. If the bank retains servicing rights, this spread can lead to significant earnings.
Secondary Market Sale
After issuing the mortgage, banks can sell it in the secondary market to investors or government-sponsored entities like Fannie Mae or Freddie Mac. The price they receive can be higher than the original loan amount, depending on demand and the loan's characteristics, such as credit quality and interest rate. Banks may earn a premium if the loan is sold for more than its face value.
Servicing Fees
If the bank retains the servicing rights after selling the loan, it can earn servicing fees. These fees are typically around 0.25% to 0.5% of the loan balance annually. Servicing fees are an additional source of income for banks that take on the responsibility of managing the loan after it has been sold.
The Actual Amount and Other Factors
The actual amount of profit from selling a loan can vary widely. It is either a percentage or a set fee. Other factors influencing the profit include the terms of the loan, the property used as collateral, the type and standing of the lenders and purchasers. Small lenders often sell mortgages to big banks due to their size and streamlined servicing processes.
After closing on different types of mortgages, lenders usually 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 in various fees. Pension funds, insurance companies, and other institutional investors purchase MBS for long-term income, but not all of them service the loans.
Lenders may continue to earn revenue by servicing the loans contained in the MBS they sell. If the MBS purchasers are unable or unwilling to process mortgage payments and handle administrative tasks involved with servicing the loan, the lenders may continue to perform those tasks for a small percentage of the mortgage value or a predetermined fee.
Conclusion
The total profit from selling a loan can vary widely depending on the specific circumstances. Banks typically earn through origination fees, interest rate spreads, potential premiums from secondary market sales, and servicing fees. Each of these elements contributes to the bank's overall earnings from the mortgage.