Do you ever wonder how lending companies make money? Mortgage lenders earn in different ways. Lenders make money out of loans. What makes them different from brokers is the fact that they lend money out of their own resources. Brokers act as middlemen between a lender and a borrower. It’s also possible for lenders to utilize depositor’s funds or they may choose to borrow money from bigger banks at an interest rate. Lenders earn from the loan as well as the interest fees obtained from the process. Let’s find out how lenders make money.
Origination Fees – since lenders use their own money when providing mortgages, they charger the borrow what you call origination fee. This is approximately 0.5% to 1% of the total value of the loan and is due with the payments. Basically, if you add the origination fee then it will also increase the borrower’s interest rate, which will affect the total cost of a home.
Let’s look at this example. Assuming you want to loan $200,000. This loan has a 6% interest rate that is payable for 30 years with an origination fee of 2%. As a bower, you’ll need to pay $4,000 for the origination fee together with other fees when the loan is closed. The monthly payment is supposed to be $1,199 based on the 6% computation. But, since you will also include the origination fee which is $4,000 then you need to divide that for 30 years. Your overall payment including the origination fee will be $1,210. If you look at the computations, you’re actually paying an 8% interest rate instead of 6% because of the origination fee.
Yield Spread Premium – mortgage lenders offer loans by using funds that come from their depositors or they can get money from banks at a much lower interest rate. YSP or Yield Spread Premium is the difference between the interest rate charged to the borrower and the rate the lender pays from the money borrowed. To help you understand, here’s an example. A lender borrows funds with a 4% interest rate to extend a loan. He then will charge the borrower a total of 6% interest rate. Therefore, the lender earned approximately 2% interest from the loan.
Discount Points – the discount point is also part of the loan and is due at the closing. This will help you get a lower mortgage interest rate. A single discount point is equivalent to 1% of the total mortgage amount. This will reduce the loan amount to up to 0.25%.
Mortgage-Backed Securities – do you know that lenders can pack less profitable mortgages with higher profit ones into packages? They call this mortgage-backed security. For example, they can tap into insurance companies and pension funds that buy these packages as their long-term income. When these are sold, lenders earn from the sale. The risk is relatively low.
Loan Servicing – when lenders service loans that are sold in mortgage-backed securities they are also earning. They do all the work like processing payments and doing other administrative tasks that are part of the loan that the buyer isn’t capable of doing. They may charge a periodic fee or ask for a percentage of the loan for their services. This is another way for lenders to make money.
Takeaway
With properties increasing in value and in cost, it can be difficult for homebuyers to pay sellers up front, which is why they turn to lenders to help them financially. Home buyers need to understand how lenders earn and how they can extend a loan to borrowers. If you are contemplating purchasing a home but you don’t have enough resources to afford it, helps to learn about the process. Certain techniques will allow you to save thousands of dollars on your loan.