While mortgage rates are at historic lows, more banks than borrowers are benefitting from the Federal Reserve’s dropped rates. In fact, the spread between the rates being offered to borrowers and banks’ costs for funding mortgages has risen sharply, The Wall Street Journal reported Dec. 3.
The thinking had been that mortgage rates would be even lower if banks were passing along their lower funding costs to borrowers, which has not been the case.
The Federal Reserve held a day-long conference Dec. 3 to investigate why banks are earning such big profits from mortgages even as interest rates have plummeted. The primary-secondary spread is historically high; after trending around 0.5 percentage points during most of the last 10 years, the rate spiked to about 1.0 in 2008 and has gone as high as 1.5 in recent weeks.
A paper presented at the conference noted several reasons for the wide spread, including the fact that banks are facing higher costs for originating mortgages. The Journal noted that from 2005-08, bank costs were $2 per $100 in loans. Today, it’s up to $5 on average.
Another reason for the spread is higher guarantee fees with Fannie Mae and Freddie Mac. G-fees have increased a quarter of a percentage point in the last year, and the two government-sponsored enterprises also have gotten aggressive about pursuing loan put-backs, leading banks to tighten lending standards. Tighter standards means that it also takes more time to process loans and banks have to foot the bill for locking in interest rates for longer periods.
Mortgage servicing costs also have gone up, particularly with so many delinquent loans, the Journal reported.
However, the Fed’s paper said that higher costs do not entirely explain the profits. Without reaching a conclusion, they floated a few possibilities: fewer players in the mortgage market, which means less competition, and high barriers to entry for new players looking to get into the mortgage market. The paper also noted that banks are charging borrowers more to refinance and that many borrowers who refinance are “held captive” by their current lenders and aren’t able to shop around for better options.
The paper concluded that, despite strong evidence pointing in the direction of capacity constraints and originators enjoying refinancing pricing power, bank profitability still “remains something of a puzzle,” the Journal reported.