MAKING SENSE -- November 25, 2011 at 1:44 PM ET
If Bank Deposits Pay So Little, Why Do Mortgages Cost So Much?
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Paul Solman answers questions from NewsHour viewers and web users on business and economic news on his Making Sen$e page. Here's Friday query:
Name: Jack McBroom
Question: My first mortgage in 1970 was at a rate of 2.0 to 2.5 percent above the bank's saving account rate. Now, savings pay virtually no interest, but mortgages are 5 percent or more. Why?
Paul Solman: I'm not sure, but after talking to a few folks, here's my best shot at an answer. First of all, a 30-year mortgage costs closer to 4 percent just now, not 5, so the spread is less than you suggest. But second, and more significantly, banks get less and less of their money from deposits; more and more, from money they themselves borrow on the open market, often referred to as "purchased funds." Given that banks aren't considered the most secure of borrowers these days, they aren't getting bargain basement terms from their lenders to "purchase" this money. So, the spread between what it costs banks to borrow for 30 years and then lend out to homeowners for 30 years is probably very slim. A lot slimmer than the difference between the deposit interest and mortgage interest rate.
Besides, banks don't actually hold onto most mortgages. They sell them into the mortgage-backed securities market, where investors get the return and take the risk. The banks make their money on fees: originating the home loan; processing it; servicing it. (Servicing means collecting the money.) As for investors making home loans, when you figure in the risk of default, you might well conclude that the surprise is how low mortgage rates are, not how high. In fact, without the participation of the government in the housing market via Fannie and Freddie, both as mortgage purchasers and mortgage guarantors, it seems likely that home loan interest rates would be higher, perhaps much higher.
A former bank CEO of considerable experience and commensurate savvy adds the following with regard to those banks which do hold onto the mortgage loans they make:
"Most banks with or perhaps even without branches have a fair amount of overhead. And this applies to the savings function as well as the lending function. And overhead probably has grown more than proportionally over the last 40-plus years (regulatory compliance of various sorts on top of rising costs of normal heat, light etc.)."
But again, remember: even the banks that hold mortgages for their own account raise much of their money by borrowing on the open market -- and rates far higher than what they pay depositors.