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
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 .
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