How Mortgage Banks Earn Fees Beyond the Interest Rate Spread
Summary
The document asks how UK banks can offer mortgage rates that appear lower than the rates paid on some deposits. Its answers challenge the idea that comparing those two rates alone reveals the economics of mortgage lending. One answer says large banks often sell originated mortgages to investors while retaining servicing rights, earning origination and servicing fees. Another emphasizes front-loaded interest in amortizing loans, though this is a personal observation rather than a general analysis of bank profitability.
Other responses suggest that deposit and mortgage rates may have different maturities or rate structures, and that fee income can be a major source of bank earnings. The thread offers several possible explanations rather than a single reconciled account. It does not provide bank filings, quantitative comparisons, or a detailed treatment of funding, capital, credit risk, and hedging, so its claims should be treated as introductory perspectives rather than a complete model.
Key ideas
- Mortgage originators may sell loans to investors and retain servicing rights, earning fees in addition to any interest spread.
- Comparing a deposit rate with a mortgage rate can mislead when the products differ in term or rate structure.
- Origination and servicing fees can contribute to a bank's mortgage-related revenue.
- Amortization schedules can put a large share of early loan payments toward interest, though that alone does not explain bank profitability.
- The discussion presents competing explanations without detailed financial evidence or a complete account of lending costs.
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Full text
# How do banks actually make money on mortgages # How do banks actually make money on mortgages This is a bit of a subjective question and relates primarily to the UK market There are a number of banks who are lending at BOE + 1.49% (ie: 1.99 %) whilst at the same time accepting deposits paying 2.75% Granted the 2.75 is a bonus rate but I just cannot understand how writing these kind of mortgages are beneficial froma a banks perspective EDIT: The terms were in fact on a two year fix with the ability to refinance tpo another provider. The answer to this question was in fact that the bank is able to artifically create moiney by fractional reserve banking and is further able to source funds from the BoE direct. ## Answer by Joshua Ulrich (score 5) https://quant.stackexchange.com/a/292 Most large banks generally sell the mortgages they originate to investors, but they retain the servicing rights. Therefore, they make money via origination and servicing fees; the spread between deposit rates and mortgage loan rates isn't as simple or important as your question suggests. ## Answer by user272 (score 1) https://quant.stackexchange.com/a/295 Check out the amortization table on your mortgage. You'll find that for the first five years, you are paying 90+% of your payment towards interest. So, if you need to sell end your loan anytime before full maturity, the majority of what you would have paid is interest, not principle. So, your effective interest rate for your specific loan duration would have been much higher. I don't think this factor is stressed enough, and really ought to be illegal. Why not just divide the interest evenly over the life of the loan so that interest and principle are applied equally? A real shameful way to do business... ## Answer by user255 (score 0) https://quant.stackexchange.com/a/279 I am no expert of banking, but hope to share my thoughts. First, bank's capital charge for mortgage is not 100%, so with $100 deposite, banks can lend out, say, $500, depending on the capital charge. Second, I think the deposit rate and the mortgage rate you mentioned is not the same duration. I am not familar with the rates in UK. It's possible that the deposit rate of 2.75% is, for example, 3 year rate, while the 1.49% mortgage rate is a floating rate (1-month rate). Usually the short term rates are lower than long term rates. Let me know if I am wrong. Thanks. ## Answer by glyphard (score 0) https://quant.stackexchange.com/a/287 A banking textbook will tell you that banks earn their profits from their net interest margin(difference between rates charged, and rates paid on banks borrowing). Your question makes it clear that the net interest margin math does not add up. Look at the 10-K (or the 10-Q for that matter) filings for a publicly traded bank that is a significant mortgage originator. What you'll see in the filings is that the income of the bank is actually driven primarily by fee income. (this fee income is overdraft fees, atm fees, and loan(mortgage) origination fees). For most banks fee income drives 50% or more of their net income. This is how they make money on doing mortgages.
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