Money supply and mortgage rates
Mortgage money is affected by the supply of and demand for loanable funds. When more funds are available relative to demand, borrowing costs tend to face downward pressure. When available funds tighten or demand rises sharply, rates tend to face upward pressure. Inflation expectations, investor demand, credit risk, loan term, and broader bond-market conditions also matter.
The Federal Reserve does not simply announce the retail mortgage rate offered to every borrower. Through monetary policy, however, it influences the availability and cost of money and credit. The Federal Reserve identifies open-market operations, the discount rate, and reserve requirements as its traditional monetary-policy tools. Changes in the federal funds rate can trigger broader changes in short- and long-term interest rates and credit conditions.
For the exam, connect supply and price: money is the product, and interest is its price. More available mortgage money generally supports lower rates; less available money generally supports higher rates, all else equal.
- Interest: price paid for using borrowed money
- Federal funds rate: overnight rate for lending reserve balances between depository institutions
- Discount rate: rate charged by a Federal Reserve Bank on qualifying loans to depository institutions
- Open-market operations: purchases and sales used to influence reserve balances and rates
- Credit tightening: reduced availability or higher cost of credit
The primary mortgage market
The primary mortgage market is where a borrower applies for and receives a new mortgage loan. The lender evaluates income, credit, assets, property value, loan-to-value ratio, debt obligations, and the applicable underwriting standards before approving or denying the application.
Primary-market lenders include commercial banks, credit unions, savings institutions, mortgage companies, and other approved lenders. A mortgage banker generally originates loans using its own funds or a warehouse line and may later sell the loans. A mortgage broker generally connects borrowers with lenders and helps arrange financing rather than funding the loan from the broker's own account.
The lender that owns the loan may hire another company to service it. Servicing includes collecting payments, managing escrow accounts, sending statements, and handling delinquency procedures. The loan owner, originator, and servicer may therefore be different organizations.
- Originator: creates the loan
- Mortgage banker: originates and commonly funds loans
- Mortgage broker: arranges loans between borrowers and lenders
- Warehouse line: short-term credit used to fund loans before sale
- Servicer: administers payments and the loan account
The secondary mortgage market
The secondary mortgage market is where existing mortgage loans and mortgage-backed securities are bought and sold. When an originating lender sells a closed loan, the lender receives cash that can be used to make additional loans. This cycle increases liquidity and helps create a more continuous supply of mortgage funds.
Loans may be pooled into mortgage-backed securities, or MBS, which are sold to investors. Borrowers still make their scheduled payments, but the economic interests and servicing rights associated with the loans may change hands. A sale does not by itself rewrite the borrower's note, interest rate, or repayment duties.
A conforming loan meets the applicable size and underwriting standards for purchase by Fannie Mae or Freddie Mac. A nonconforming loan does not meet one or more of those standards. A jumbo loan is a common nonconforming example because its amount exceeds the applicable conforming limit.
- Loan sale replenishes lender funds
- Pooling combines many mortgages
- Securitization creates mortgage-backed investments
- Conforming loan meets enterprise purchasing standards
- Nonconforming loan falls outside one or more standards
Fannie Mae, Freddie Mac, and Ginnie Mae
Fannie Mae and Freddie Mac are congressionally chartered government-sponsored enterprises. The Federal Housing Finance Agency explains that they buy mortgages from lenders, hold some loans, and package others into mortgage-backed securities. Lenders use the cash from those sales to make more mortgage loans.
Fannie Mae and Freddie Mac are not the FHA or VA. FHA insures qualifying loans made by approved lenders, while VA guarantees part of qualifying loans for eligible borrowers. Fannie Mae and Freddie Mac operate in the secondary market by purchasing qualifying loans and supporting mortgage liquidity.
Ginnie Mae is a wholly owned U.S. government corporation. It does not originate home loans. Its central secondary-market role is guaranteeing the timely payment of principal and interest on qualifying mortgage-backed securities backed by federally insured or guaranteed loans, including eligible FHA and VA loans.
- Fannie Mae: secondary-market purchaser and securitizer
- Freddie Mac: secondary-market purchaser and securitizer
- Ginnie Mae: guarantees qualifying mortgage-backed securities
- FHA: insures qualifying mortgage loans
- VA: guarantees part of qualifying mortgage loans
Mortgage fees, points, credits, and APR
An origination charge compensates the lender for creating and processing the loan. Other charges may include underwriting, application, appraisal, credit-report, rate-lock, title, and settlement-service costs. The exact charges depend on the lender, loan, service provider, and government program.
One discount point equals 1% of the loan amount, not 1% of the purchase price. Paying discount points increases upfront closing costs in exchange for a lower interest rate than the lender's comparable zero-point option. The exact rate reduction per point is not fixed and depends on the lender, loan type, and market conditions.
A lender credit works in the opposite direction: the borrower receives help with upfront costs in exchange for a higher interest rate. The Loan Estimate shows important loan terms, projected payments, origination charges, points, lender credits, estimated closing costs, and cash to close. The annual percentage rate, or APR, is a broader credit-cost measure than the note interest rate because it incorporates specified finance charges under federal rules.
- One point: 1% of the loan amount
- Discount points: more cash now for a lower rate
- Lender credit: less cash now for a higher rate
- Interest rate: price applied to the loan balance
- APR: broader annualized measure of credit cost
- Loan Estimate: standardized form used to compare loan offers
Worked mortgage-fee example
A buyer obtains a $320,000 mortgage. The lender charges 1.5 discount points and a 1% origination charge. Calculate each charge and their combined amount. Ignore all other closing costs.
Discount points: $320,000 x 0.015 = $4,800. Origination charge: $320,000 x 0.01 = $3,200. Combined charges: $4,800 + $3,200 = $8,000.
Both calculations use the loan amount. The $400,000 purchase price, if one were provided, would not be used for calculating these percentage-based loan charges unless the question expressly defined a different base.
- Loan amount: $320,000
- 1.5 points: $4,800
- 1% origination charge: $3,200
- Combined amount: $8,000
QUICK REVIEW
Say these aloud
- The primary market originates loans for borrowers; the secondary market buys, sells, and securitizes existing loans.
- Fannie Mae and Freddie Mac buy loans from lenders, while Ginnie Mae guarantees securities backed by government-insured or guaranteed loans.
- One discount point equals 1% of the loan amount, so 1.5 points on a $320,000 loan cost $4,800.
KNOWLEDGE CHECK
Five-question quiz
Choose your answers, then check your score.
Licensing-path action
Download or view a sample Loan Estimate from the Consumer Financial Protection Bureau. Locate the loan amount, interest rate, APR, origination charges, points or lender credits, estimated closing costs, and cash to close. Then recalculate the $4,800 points charge without looking at today's example. Continue or enroll in a FREC-approved 63-hour pre-license course; License Lab is supplemental only.