Why would a bank lend out mortgages when rates are so low?


Aren’t banks trying to make money like every other business? If ROI on mortgages is only 2.5%, but market investments are 7%+, why do banks lend out mortgages at all? Is it a low risk thing? How do banks decide how much of their portfolio goes toward lending out mortgages?

In: Economics

> If ROI on mortgages is only 2.5%, but market investments are 7%

Average historical ROI is only one component of several that must be considered when making an investment. Also important are tax efficiency and risk.

It has to do with balancing risk and return. Mortgages are backed by the government and by an asset that typically appreciates in value. Think of it as eating the salad at lunch to compensate for the ice cream for dessert later (the higher but inconsistent market returns).

Depending on where you are in the world, the fees banks charge on mortgages make it worthwhile.

[this site](https://www.creditkarma.com/home-loans/i/fees-when-buying-home) shows some of the fees you might expect from a mortgage in the US.

To qualify for a low interest home loan, the buyer needs to have a reasonably solid credit score, put a significant down payment on the loan, and carry insurance on the property. If the loan goes into default, the bank can foreclose on the property for auction. If the property is seriously damaged or destroyed, the insurance company takes the loss. The only real risk the lender faces on any given loan is if the debtor defaults *and* there is a significant decline in the fair market value of the property.

Take that single low risk loan, bundle it with 10,000 other low risk loans, scattered across the country and at varying stages of maturity, and you have an investment product that is very secure with almost no risk of loosing value for your investors.

As an individual investor, if you have money you aren’t using but you can’t risk loosing (e.g. your emergency fund), and you want some protection against inflation, this is a fairly good place to put some of it.

Over a long enough timeline, the broad stock market will almost certainly outperform a mortgage backed security, but in any given moment you may face significant loss of value. If we’re talking about that emergency fund, when the next recession comes around you can’t afford to have it loose value just as you are most likely to loose your job .

Banks can loan money from very risk-averse investors. The mortgage can be divided into parts with different risks. Let’s house can be sold for 70 % of the loan capital, and that 70 % is practically risk-free and bank can loan money with 0.5 % interest for that amount. The rest of the mortgage is risky, but it gets higher share of the interest, totaling 7+% for the risky part.

Also keep in mind that most banks that lend for mortgages don’t keep the loan, at least in the US and I assume it’s similar elsewhere. So, let’s assume you borrow from a smaller, local bank to buy a home. They lend you the money, the loan “closes” (everything trades hands, you end up with the keys, the seller ends up with a check, etc.) Remember, this is a small bank, and by rules they have to keep a portion of money in reserve to cover outstanding loans, so if they keep the loan in house, at some point, they don’t have any more money to lend because it’s all tied up in reserves. So, they sell the loan to say, Bank of America or Chase, much larger banks with much larger reserves. The debt is completely cleared from the local bank, and the last you will hear from them is receiving a letter that says X bank is now your servicer and you will make payments to them. Even these bigger banks are likely to divide the loan into two parts, servicing and holding. The servicer accepts the payments, manages the escrow fund to cover insurance and taxes and the like, etc and then passes the principle and interest on to the holder. If the local bank sold to Chase, Chase likely keeps the servicing. They charge a fee for such services to the holder on a month to month basis, and servicing a million loans isn’t much more taxing than servicing one hundred. They sell the holding, though, to Fannie Mae, Freddie Mac, or Ginnie Mae which are government backed, or private investments looking for low-risk investment. This is usually done in large lots called mortgage backed securities. So, you get a house, the local bank gets a one time payment for selling the loan plus fees charged at closing, Chase adds another loan to its servicing portfolio, and some large, well funded group adds to their portfolio of highly safe investments.