Understanding and Influencing Mortgage Rate Differences Between Lenders

When applying for a mortgage, you might notice significant differences in the interest rates offered by various lenders. This article explores the factors that influence these differences and what you can do to find the best rate for your needs.

The Fundamental Business Model of the Mortgage Industry

To understand why there is a pricing difference between lenders, it is essential to delve into the fundamental business model of the mortgage industry. When you apply for a mortgage, whether from a commercial bank or a non-depository mortgage banker, the lender underwrites, approves, and funds the loan, knowing that they will sell it to an investor as soon as possible. This typically happens within days after the loan is funded.

The loans are ultimately sold to one of three major investors: Fannie Mae, Freddie Mac for conventional loans, or Ginnie Mae for FHA and VA loans. The investors purchase the loans for a premium over the Note Rate, which is the interest rate the borrower pays. Over time, the investors receive their return as the borrower repays the principal and interest.

The money the lender provided comes from a specialized line of credit called a warehouse line. The investor purchases the loan at a premium, for example, at 104% for a $100,000 loan. The lender pays off the warehouse line, covers origination costs, loan officer’s commissions, overhead, and other expenses. The remaining amount is their profit.

Consistent Loan Pricing Terms

Lenders sell their loans to investors on the same terms, meaning that if one company can sell a loan to Fannie Mae for $104,000 today, another company cannot sell the same loan for a higher price unless they are charging discount points. It is important to know that there is not a vast margin when the lender sells the loan to the investor, and the difference in rates between lenders is related to the profit they expect to earn on the loans they originate, fund, and sell.

A difference of 0.25 in rate means a difference in the price the investor will pay of about 1% of the loan amount. Some lenders may advertise rates significantly lower than others because they are charging discount points. For example, if the “par” rate today for a 30-year fixed rate mortgage is 4.5% (meaning the borrower pays no points), a loan where the borrower pays 1% of the loan amount would be closer to 4.25%.

Online Lenders and Their Pricing Strategies

Online lenders often advertise lower rates because their “loan consultants” are typically call center operators who primarily answer calls and guide people to submit loan applications. Since they do not provide advice and guidance, their companies can keep costs lower and offer lower rates. However, there is a downside to this approach. The “pull-through rate,” the percentage of successfully funded loans, is often lower for call center companies compared to local lenders. Local lenders’ loan officers usually have more experience and can better advise clients, which is critical for ensuring timely closings and avoiding delays with out-of-state lenders.

Factors that Determine Your Rate

Understanding the variables that determine the rate can help you make informed decisions. These include:

Borrower’s Credit Score: Lenders use "risk-based pricing." This means they consult a matrix containing credit scores and loan-to-value ratios. The borrower’s credit score and loan-to-value ratio will determine the adjustment to the "raw" pricing. For example, two borrowers applying for the same type of loan for 80% of the property’s value but with different credit scores will receive different rates. Property Type: An 80% loan for a condominium will typically have a higher rate than for a single-family detached home. Loan Purpose: A borrower seeking to refinance to get cash out of their equity will typically receive a higher rate than for a loan of the same loan-to-value ratio to purchase a home. Timing: Mortgage rates are determined each day based on the price of Mortgage Backed Securities. These fluctuate daily according to market forces, affecting rates. A movement of 25 basis points (0.25%) can significantly impact the interest rate.

Complexity and the Importance of Understanding Your Situation

While online lenders can offer competitive rates, it is important to consider the complexity of your situation. Variable income, income from self-employment, investments, and rental properties can present potential roadblocks to a successful closing. If and when a problem arises, the presence of an experienced and knowledgeable person can mean the difference between a timely closing and an endless delay.

In conclusion, understanding the pricing structure and the factors that influence mortgage rates can help you make informed decisions when applying for a loan. By considering the type of lender, your specific situation, and the rate variables, you can find the best rate for your needs.