A mortgage company is a type of lender that provides various types of home loans for people who want to buy a home. A mortgage company can make money in various ways. Usually, a Mortgage company makes money from origination fees, yield spread premiums, discount points, closing costs, loan service, mortgage-backed securities, etc.
How Does a Mortgage Work?
A mortgage is considered as the largest and longest-term loan that will help you buy your own home. When you take a mortgage loan, you are agreed to repay the money at a pre-agreed interest rate. Here, your home will be considered as the collateral. It means, if you fail to repay the loan amount in time then the bank can legally foreclose your property. A mortgage loan will have below details –
- Interest rate
- Total loan amount
- Term of the loan
- Late payment fees
- Monthly principal and interest payment
If you have a mortgage then every month you have to make a mortgage payment. In most case, a mortgage payment has at least four different buckets. They are –
- Principal: This is the portion of you loan amount that you have to pay every month.
- Interest: You have to pay a monthly interest rate on your total loan amount.
- Taxes: You have to pay the yearly property tax bill each month. You have to pay 1/12th of your yearly property tax based on how much is assessed!
- Insurance: You will need an insurance coverage to protect your house from various accidents and environmental hazards. Your insurance payment is usually included in the mortgage payment.
How Does a Mortgage Company Make Money?
A mortgage company make money on your mortgage loan. Basically, they make money from various fees including origination fee, late fee, etc. Some common source of income for a mortgage company are –
- Origination Fees
- Yield Spread Premium
- Discount Points
- Closing Costs
- Mortgage-Backed Securities
- Loan Servicing
1. Origination Fees
This is a common earning source for a mortgage company. When you want to extent your mortgage, you should understand that lenders use their funds. Therefore, they charge origination fees and it can range from 0.5% to 1% of the loan value.
Typically, the origination fee is due with mortgage payments. Origination fees increase the annual percentage rate (APR) of the mortgage as well as total cost of the house. For example, if you have a $200,000 loan with a 6% interest rate and loan term of 30 years then you have to pay a 2% origination fee. So, your origination fee will be $4,000. Usually, the monthly payment for a $200,000 mortgage with a 6% interest rate is $954. But when you add the $4000 origination fees, then your loan payment will increase by $19 per month and your total monthly payment will be $973.
2. Yield Spread Premium
Usually, mortgage companies borrow money from large banks at low interest rate and then lend money at higher interest rate. The difference between the interest rate that a mortgage company charge to the borrower and the interest rate that they pay to the bank is known as the yield spread premium (YSP). For example, if the mortgage company borrow money at 4% interest and extends a mortgage at 6% interest then the interest difference is 2% and it’s the income of a mortgage company.
3. Discount Points
This is another way a mortgage company can make money. Usually, discount points help the borrower buy down the mortgage’s interest rate. Depending on the company one discount point can be equal to 1% of the mortgage amount and may reduce the loan amount by 0.125% to 0.25%. So, if you have a mortgage of $200,000 then two points will be 2% of the loan amount, or $4,000. So, if you pay the points early then it will lower your monthly payments. How many discount points you can use depends on the mortgage company, type of mortgage, market condition, etc.
4. Closing Costs
If you want to close your mortgage loan then you also have to pay a closing fee. Usually, the closing fee varies depending on the mortgage company, and you have to pay the closing fee upfront in the good faith estimate (GFE). So, when you are purchasing a mortgage loan, you have to carefully read the list of fees that you have to pay along with the mortgage interest rate. You can negotiate certain fees with the mortgage company to save some money on various fees.
5. Mortgage-Backed Securities
This is another way mortgage companies can make money. In many occasions borrowers fail to pay the mortgage loan; in this type of situation the mortgage company converts the varying profit levels into mortgage-backed securities and then sell them for a profit. This way the mortgage company frees up some money and give new mortgage loans and earn more income. Typically, the insurance companies, pension funds, and other financial institutes or investors purchase the MBS for long-term income.
6. Loan Servicing
Mortgage companies also earn from various loan services. In many case the mortgage company continues to service the loans sold in their mortgage backed securities. For example, the mortgage company can process the payments as well as conduct all of the administrative tasks that are connected with the mortgage loan. Usually, the lender charges a small percentage of the loan or a periodic fee in exchange for servicing the loans.
FAQs about How Does a Mortgage Company Make Money
How much profit do mortgage companies make?
The answer to this question depends on quite a few things. Usually, a mortgage company charge a commission of around 1%-2% of the loan value. According to Mortgage Bankers Association, independent mortgage banks and mortgage subsidiaries of chartered banks on an average has earned $1,820 on each loan!
Do banks make money on mortgages?
Yes, banks make money on mortgages. However, their earning process is bit different from traditional mortgage companies. Banks usually take the mortgage and converts them into bonds and then sells them to private investors, pensions and mutual funds. The higher the interest rate of the mortgage, the more the bank will earn.
How much do banks pay mortgage brokers?
The answer to this question varies depending on the bank you have chosen. According to many financial experts, the banks might pay as high as 1% of your loan amount to the mortgage brokers. For example, the brokerage could earn $5,000 from a $500,000 home loan.
How do lenders make money when giving out loans?
There are many ways lenders can make money while giving out loans. In most case, the lenders make money from loan origination fees and interest rates. Apart from that lenders also make money from loan closing fees, late payment fees, loan origination and many more.
What are the types of mortgage loan?
There are quite a few types of mortgage loans available. 5 common types of mortgage loans are –
- Conventional loans: These types of loans are not backed by the federal government and are best for people who have an excellent credit score.
- Jumbo loan: If you have an excellent credit score and if you want to buy an expensive house then it will be the best option for you.
- Government-insured loan: Insured by the government and best for people with lower credit scores and if they require a lower down payment.
- Fixed-rate mortgage: Here the rate is fixed for the whole loan amount and best for people who want the same payments throughout the entire loan.
Adjustable-rate mortgage: In this type of loan, the interest rate is not fixed and it can go up or go down.
Last Updated on August 7, 2022 by Ana S. Sutterfield
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.