Image courtesy of BeSmartee, Mortgages Across the USA
There are several factors that influence changes in mortgage rates. Nationally, the service release premiums (SRP), the prime rate, London Interbank Offered Rate (LIBOR), bond yields, inflation and mortgage-backed securities all have an effect on interest rates. Regionally, the borrower demand, local property values, mortgage default rates and unemployment rates can also play a part in mortgage rate variation.
As you can see there are many factors considered when lenders determine what interest rate to charge which borrowers. The two primary factors are really:
For example, states that tend to have higher loan amounts also tend to have lower interest rates. Also, states, counties or regions that have lower average loan amounts or a higher risk of mortgage defaults will tend to have higher interest rates.
If I had to pick one primary factor to describe the variation in mortgage rates, it would be the risk. This is why the underwriters position at the lenders office is so important. All the documents you fill out, submit, and pay for, including appraisals and home inspections get funneled to the underwriter who then reviews all of the information and assess the risk level of the investment. Less risky? Lower rate. Riskier? Higher rate. What higher rates do is ultimately mitigate the risk of loss. That's all.
With that said, however, some lenders will give borrowers higher rates than they actually qualify for because they want to make money when they sell a borrower's loan to a loan servicing company, or another investor. This is where Service Release Premiums (SRP) come into play with regards to higher interest rates. So what are SRP's?
Most mortgage lenders, including brokers and banks, don’t hold your loan for long after it closes. They sell it to loan servicers and collect a payment from them known as Service Release Premium or SRP. It was given this name because the lender who originally wrote the loan releases the right to “service” the loan. It's important to note that when a loan is sold, nothing on the loan changes except where the payment is sent.
There is a secondary market for your loan that generally likes you to have a higher interest rate.
When mortgage service companies buy a loan, they pay for the future income they will receive from the interest rate on a particular mortgage. The higher the rate on the loan, the more the loan is worth to investors. Lenders make more money from the SRP on loans with higher interest rates, and make less money on loans with lower interest rates. You can begin to see how there may be an incentive to give borrowers higher rates.
Borrowers often qualify for lower rates than what lenders end up offering due to the SRP I just mentioned. The higher the rate a borrower accepts, the higher the SRP the lender can collect when they sell the loan to investors. If it weren't for competition amongst lenders, there would be no need to offer borrowers the lowest interest rates. This is one of the primary reasons why competition amongst lenders is a great thing for consumers.
Loans with no upfront costs will tend to have higher interest rates than loans that have lender fees and closing costs. When considering a no cost loan, the lenders fees and closing costs are essentially paid for by the SRP. In order to get enough SRP to pay for the closing costs, the rate will be higher. The tradeoff for a higher rate is that you pay nothing out of pocket, except for the appraisal. The closing costs are ultimately paid for by the SRP.
If a borrower wants a lower rate, the lender must credit a portion of the SRP towards some of the loan costs and the borrower pays the remainder of the closing costs. As the rate goes down, so does the SRP lenders receive when they sell a loan. With lower interest rates, there’s less SRP to credit towards the loan costs. This is why borrowers have to make up some of the difference. If borrowers don’t want to pay the loan costs up front, most loan programs will let you roll the costs into the new loan.
What about borrowers who want the lowest rate possible? Naturally this means lenders will receive a very low SRP. If the SRP is not enough to cover the loan costs, then this is when borrowers must pay "points", or percentages of the loan amount, to make up the difference, in addition to other closing costs.*Suit and tie image source: Pixabay.
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