Banks rely largely on retail deposits to fund their mortgages, which is an old practice. Since the mid-20th century, banks and building societies have taken money from their customers’ savings accounts to lend for mortgages. This practice is still particularly important today for institutions such as building societies, which in the UK are required to raise at least 50% of their funds from customer savings.
Despite changes in banking practices over time, retail deposits remain an important source of mortgage funding. Savings products such as savings accounts, fixed-term accounts and individual savings accounts (ISAs) provide banks with stable, long-term capital to lend. For example, 61% of people in Australia prefer retail deposits, and savings accounts are the most popular of these. In addition, money held in current accounts also helps fund mortgages, although it is more liquid, it is still useful for lending.
Retail deposits provide a stable and affordable way for banks to maintain their lending capacity and continue to provide mortgages to customers.
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How Do Banks Raise Funds For Loans Through Modern Means?
When banks run out of deposits from the public, they borrow money from larger institutions or financial markets to lend to people. This is called wholesale funding. This gives banks more money, cheaper loans, and more freedom to lend to more people.
1. Covered Bonds
This is a special type of bond that is issued by the bank itself, and is backed by collateral — such as mortgages that the bank has already given. If the bank cannot repay the loan, the buyer can get the house as collateral.
These bonds seem safe to investors because they are backed by an underlying asset (the house), and are often accepted by central banks such as the Bank of England or the European Central Bank.
2. Private Bank Financing
Sometimes a bank borrows directly from other banks or financial institutions to meet an urgent need. The terms are easy, and the interest rate is relatively low. This method is especially useful when the bank has low deposits but needs to lend to people urgently.
3. Warehouse Line of Credit
This facility is especially for institutions that issue a lot of home loans (mortgages).
These institutions are given a large loan temporarily, which they use to make loans. Later, when they sell these loans or transfer them to a large investor, they return the original money.
This is a revolving system, meaning it can be repaid once and used again.
4. Central Bank Funding
When there is a market crisis, such as the 2008 financial crisis or the Corona crisis, banks seek help from the central bank. These institutions lend the bank cash for a period of time, in exchange for which they hold their loans as collateral.
This is a safety net so that banks can continue to operate and ordinary people can get loans.
5. Mortgage-Backed Securities (MBS)
This is a bit technical, but in simple terms, it goes like this:
- The bank collects hundreds of home loans, packages them up, and sells them to large investors. This process is called securitization.
- Investors who buy these packages get back the money that people put up in their loan installments.
This process helps the bank free up money to make new loans, because it sells old loans on.
6. Corporate Bonds
Banks sometimes issue ordinary bonds, like those a company might issue for its own growth. These bonds are also bought by investors, and the bank promises to pay them back their money over a certain period of time, along with interest.
This method gives the bank money for a long period of time, allowing them to raise capital for home loans or other projects.
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Role of Mortgage Bankers and Brokers
Mortgage bankers and mortgage brokers are central figures in the home financing industry. Though both help consumers secure mortgage loans, their roles, responsibilities, funding sources, and compensation models differ significantly. Understanding the distinction between them is key for borrowers navigating their home buying or refinancing journey.
Mortgage Bankers
Mortgage bankers are direct lenders. They use either their own capital or funds borrowed from larger financial institutions to originate loans.
Originate Loans Using Their Own Funds or Borrowed Capital
Mortgage bankers have control over the lending process, from funding application. Because they fund the loan themselves, they can offer customized lending solutions, set their own interest rates and terms, and ensure faster processing.
May Hold Loans or Sell Them
Once the loan is originated, mortgage bankers can either:
- Retain the loan in their own investment portfolio and earn ongoing interest income.
- Sell the loan on the secondary market (e.g., to Fannie Mae, Freddie Mac, or private investors) to free up capital and reduce risk. This is common in mortgage-backed securities (MBS) transactions.
This ability to sell loans helps mortgage bankers maintain liquidity and continuously offer new loans to customers.
Earn Fees from Origination and Servicing
Mortgage bankers typically generate revenue in two ways:
- Loan origination fees paid by the borrower at closing.
- Servicing fees if they manage the loan post-origination. This includes collecting monthly payments, handling escrow for taxes and insurance, and communicating with borrowers.
In many cases, they may outsource servicing or transfer it along with the loan.
Mortgage Brokers
Mortgage brokers act as intermediaries between borrowers and multiple lenders. They do not lend money directly but instead help borrowers find the most suitable mortgage product from a variety of sources.
Facilitate Loan Origination for Lenders
Brokers assess the borrower’s financial situation and loan needs, then match them with appropriate loan programs from the broker’s network of lenders. They manage the application process, negotiate terms, and ensure all documents are complete and compliant.
Because they work with many lenders, brokers can offer wider product choices—beneficial for borrowers with unique credit profiles or special loan requirements.
Do Not Use Their Own Funds
Mortgage brokers never use their own capital to fund loans. Instead, they connect borrowers to third-party lenders who underwrite and fund the loan. This means brokers take on less financial risk but also have limited control over loan approval timelines and final terms.
Earn Commissions from Lenders
Mortgage brokers earn money through:
- Commissions paid by lenders for originating the loan (also known as yield spread premiums).
- Occasionally, fees charged to the borrower (though this must be disclosed under federal law).
The compensation structure must comply with federal and state mortgage regulations, including the Truth in Lending Act (TILA) and Dodd-Frank rules.
Key Differences: Mortgage Bankers vs. Mortgage Brokers
| Aspect | Mortgage Bankers | Mortgage Brokers |
| Funding Source | Use own funds or borrowed capital | Do not use own funds; act as intermediaries |
| Loan Origination | Directly originate and fund loans | Facilitate origination with third-party lenders |
| Revenue Source | Origination fees, servicing fees | Commissions from lenders; sometimes fees from borrowers |
| Loan Ownership | May retain or sell loans after origination | Never own loans; lender retains the mortgage |
| Control Over Terms | High—can set rates and conditions | Limited—depends on lenders’ terms |
| Product Range | Limited to the bank’s own offerings | Broad access to various loan products and lenders |
Profitability for Banks
Banks fund mortgages using a combination of strategies to balance profitability and manage risks. These strategies help ensure they can offer competitive mortgage products while safeguarding their financial stability.
Interest Rate Spread
The interest rate spread is the difference between the interest charged to borrowers and the cost of funds (e.g., interest on deposits or borrowed funds). This spread is a primary source of net interest income for banks. A wider spread generally leads to higher profitability, as the bank earns more on its mortgage loans than it pays to fund them.
Fees
- Banks also generate income through various fees:
- Origination fees for processing mortgage applications.
- Servicing fees for managing loans and escrow accounts.
Additional charges like late payment or early repayment fees. These fees provide additional revenue streams, enhancing profitability beyond just interest income.
Risk Management
Selling Loans in the Secondary Market
To manage credit risk and improve liquidity, banks often sell mortgages to investors or other financial institutions through securitization. This reduces the bank’s exposure to defaults and allows them to free up capital for new loans.
Using Hedging Instruments
Banks use hedging instruments such as interest rate swaps to manage interest rate risk. This helps them protect against losses from changes in interest rates, ensuring more stable earnings and reducing volatility in their mortgage portfolios.
Underwriting Standards
Underwriting standards involve assessing a borrower’s creditworthiness. Banks use these standards to minimize default risks by evaluating factors like credit scores, income stability, and debt-to-income ratios. Strict underwriting ensures that only qualified borrowers receive mortgages, thus reducing potential losses for the bank.
How much do mortgage lenders make per loan? Lenders typically earn 0.5% to 1% of the loan amount as an origination fee, plus potential income from closing costs and selling the loan.
How much do banks make selling mortgages? Banks profit from origination fees, closing costs, and by selling mortgages on the secondary market, often retaining servicing rights. Profitability can vary.
What are the 4 types of mortgage loans? Common types include conventional (not government-backed), government-backed (like FHA, VA), fixed-rate (interest stays the same), and adjustable-rate (interest changes).
Mortgage bank example: Examples include Rocket Mortgage, United Wholesale Mortgage, and the mortgage divisions of large banks like Wells Fargo and Bank of America.
Who do banks sell mortgages to? Banks often sell mortgages to investors on the secondary market, including Fannie Mae and Freddie Mac, who may package them into mortgage-backed securities.
Mortgage vs loan: A loan is general borrowing. A mortgage is a specific loan for real estate, secured by the property.
How does a mortgage work for first-time buyers? First-time buyer mortgages are similar to regular mortgages but may have easier requirements (lower down payments, credit scores) and often include assistance programs. You borrow money to buy a home and repay it with interest over time.