How Primary Lenders Earn Money From Mortgage Origination
Uncover how primary lenders generate immediate revenue from mortgage origination, detailing their upfront profit models and strategies.
The primary mortgage market is where borrowers directly obtain new mortgage loans from lenders. This initial interaction involves banks, credit unions, and mortgage bankers. Loan origination is the process of creating a new mortgage, from application to funding. This article explains how primary lenders generate revenue at the point of loan origination.
Direct Fees at Origination
Primary mortgage lenders charge fees directly to the borrower at loan origination. These charges compensate the lender for their services in setting up the loan. One common charge is the origination fee, which ranges from 0.5% to 1% of the total loan amount. This fee covers the lender’s administrative costs for processing, underwriting, and funding the mortgage.
Borrowers may also encounter discount points, an upfront payment made to the lender in exchange for a lower interest rate over the life of the loan. One discount point equals 1% of the loan amount and can reduce the interest rate by 0.25%. These points provide immediate income to the lender at closing, increasing the loan’s yield.
Additional direct charges include application fees, which are administrative costs for processing the initial loan request, ranging from $200 to $500. Underwriting fees, between $300 and $1,595, cover the lender’s expense of assessing the borrower’s creditworthiness and the property’s value.
Yield Spread and Interest Rate Premiums
Primary lenders can also generate immediate income through the interest rate set at origination, even if they plan to sell the loan quickly. While lenders earn interest for the brief period they hold the loan, this is a smaller component of their origination revenue. The more significant immediate profit mechanism related to interest rates is the yield spread premium (YSP), also known as a lender credit.
A yield spread premium is a payment made by a secondary market investor to the primary lender when the lender originates a loan with an interest rate higher than the prevailing market rate, known as the “par rate.” This higher interest rate makes the loan more valuable to the investor, who then pays a premium to the originating lender. This payment provides immediate profit to the primary lender at the time of origination.
From the borrower’s perspective, they might opt for a higher interest rate in exchange for a lender credit, which can reduce their upfront closing costs. This arrangement allows the lender to receive compensation through the premium paid by the secondary market, effectively covering some or all of the borrower’s closing expenses. Thus, the interest rate structure at origination directly influences immediate revenue for the primary lender, distinct from the long-term interest earnings on the loan itself.
Selling Loans to the Secondary Market
A primary revenue strategy for lenders at origination involves selling loans to the secondary mortgage market. Lenders, including commercial banks and credit unions, originate loans but do not hold them for their entire term. Instead, their business model focuses on originating these loans and then selling them to investors. Key buyers in this market include government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, as well as various private investors.
Lenders realize profit through “gain on sale” when they transfer these loans. This gain represents the difference between the price at which the loan is sold to the secondary market and its cost to originate. The secondary market pays a premium for loans that meet specific standards, providing immediate liquidity and profit to the originating lender. This process allows primary lenders to recoup their capital quickly, enabling them to originate more loans without exhausting their funds.
Selling loans also helps primary lenders manage interest rate risk and maintain liquidity for their operations. While the sale of the loan generates immediate origination profit, primary lenders sometimes retain the “servicing rights” for the sold mortgages. Servicing rights represent a separate revenue stream, where the original lender continues to collect payments, manage escrow accounts, and handle other administrative duties on behalf of the loan’s new owner. This distinction highlights that the gain on sale is a distinct profit realized at the point of origination, separate from ongoing servicing income.