Mortgage math is hard.
August 29, 2012 2:12 PM   Subscribe

Please help me understand this mortgage math.

In August 2008, I bought my first house with an FHA 30-year fixed-rate mortgage. The loan amount was $250K and the interest rate was 6%, the lender was Wells Fargo, and the P&I was around $1475, I think (don't have the old note handy). PITI was about $1850.

I just closed yesterday on an FHA Streamline refinance. The lender is still Wells Fargo and the loan amount is $238K. The interest rate is 3.5% and the P&I is $1070 (PITI is $1440). I brought almost nothing to the closing -- the lender credit was around $10K for all closing costs, including the funds for the new escrow account. I'll be getting the old escrow funds back in the mail (about $2600).

How does this even make sense, as in, how do they make money on this? They pay $10K so I can pay them $400 less per month. The loan isn't that old, so it's not a huge amount of time reset on the clock (though I understand that that is usually the catch in the refi game). The house is way underwater and we have half the income we had when we qualified the first time around. Also, we turned it into a rental last year. I understand that FHA has streamline refinance guidelines, but I also understand that most lenders have "overlays" on top of those. Does Wells not have overlays?

Bonus question: how much extra, if any, do I need to pay per month to not pay MORE interest than I would have with the original loan?
posted by rabbitrabbit to Work & Money (15 answers total) 4 users marked this as a favorite
No cost, lower-interest refi's are quite common nowadays. I'm doing one right now (after buying the house last year). I'm not sure how they make money on this... though I'm guessing there is some government/tax incentive.

At the end of your original loan, you would've paid 285,845.47 in interest. At the end of the new loan, you would've paid 146,741.49 in interest. So you will be paying less interest with the new mortgage.
posted by ethidda at 2:24 PM on August 29, 2012

They write off the difference as a "loss", the lending agent gets a commission, they receive federal money, and they get to add it to their internal metric as a fulfilled mortgage AND a new mortgage.

It's a game, and they always win, even if they should be losing.
posted by Bathtub Bobsled at 2:27 PM on August 29, 2012

Best answer: If you qualify for a better loan than you originally had, it's in their interest to make you the new loan, instead of you going to another bank to get the new loan.
posted by endless_forms at 2:34 PM on August 29, 2012 [2 favorites]

Best answer: You're making the wrong comparison. The choice isn't between "give the borrower $10,000 and let him pay $400/mo less" and "make him keep his current rate and make more money". The choice is between "give the borrower $10,000 and let him pay $400/mo less" and "let the borrower refinance with someone else and never make any more interest on the loan again ever".

If you're shopping for a new loan, chances are you're going to get it from somebody. It's in Wells Fargo's interest that that somebody be them, even if it isn't as good of a deal for them as they had before. Keeping you on the old terms wasn't really an option, unless they were willing to bet that nobody else would give you a loan (unlikely).
posted by Vorteks at 2:37 PM on August 29, 2012 [3 favorites]

Best answer: How does this even make sense, as in, how do they make money on this? They pay $10K so I can pay them $400 less per month.

The lender credit is being paid for by charging you a slightly higher interest rate. Say Wells can probably sell your mortgage to Ginnie Mae at a 3% rate. At a yield of 3.5% your mortgage is worth 100 cents on the dollar (so $238,000). But pricing the same cash flow stream at 3% results in a value of 107 cents on the dollar or about $255,000. Wells Fargo just made a profit of $15,500 this way. Plus Wells will likely continue to service the loan even after they sell it, which creates a fee stream of 0.25% per year.

FHA and Ginne Mae are subsidizing your mortgage by paying a higher price than they probably could. The spread between your interest rate and the yield Ginne Mae will buy at is probably not as large as the numbers I used, but hopefully you get the idea.

Wells would still rather have that original 6% mortgage. But that mortgage is probably pooled into a Ginnie Mae security anyway, so the pre-payment "loss" accrues to the bond investors. Even if Wells did hold that mortgage it's a sunk cost. You could refi that mortgage anywhere, so from Wells perspective it might as well be them.
posted by mullacc at 2:37 PM on August 29, 2012

We're going through a similar process and will save around $14K over the life of the loan. I don't know much about the other issues, but I do know our mortgage agent is very keen on completing this transaction for his commission and the lender is very keen on us not going to another bank. Less money beats no money every time.
posted by advicepig at 2:38 PM on August 29, 2012

The answers about not LOSING the business are right on. If you paid some fees, that's also money made for the banks. One tends to look at the total interest potentially to be paid on the life of the loan, but most mortgages don't go to term. So the long game may not be as important as fees earned by turnovers.

That's not to say you made a bad decision; it sounds like you made the right one.

It's also true, if you're wondering how do banks make money at such low interest rates - they don't make much. But lending at low interest rates is the only game on the table right now. The alternative is to have funds that they can't lend out, and money that's not lent out (beyond necessary reserves) is REALLY bad for the banks. For most of us, money is an asset; for a bank, it's inventory, and it's got to turn, regardless of what the rates are. That's why banks are having such a hard time, consolidating, and also why retail banking and credit card fees are going up so much.

What will be interesting, say 10 years from now, is what possible enticements the banks will be offering to try to pry those of us with low interest rate mortgages out of those mortgages, if we're fortunate enough not to have to move and upset the apple-cart.
posted by randomkeystrike at 3:02 PM on August 29, 2012

Best answer: Mullacc is spot-on with how the mortgage lenders & originators make money on this. See these pages from the awesome mortgage professor site: no-cost mortgage and negative points

The mortgage originators/brokers can get a low rate on the wholesale mortgage market, and mark up the rate by "negative points," or rebates to you, the borrower, to pay for the closing costs minus taxes and pro-rated interest on the previous mortgage. Over the life of the loan, they are making the difference between the retail rate and the wholesale rate, basically.
posted by scalespace at 3:20 PM on August 29, 2012

In terms of what they expect to pay on a risk adjusted basis, they're making out like bandits. Lowering your payments means you're more likely to pay them. Plus they get government money to pay for most of that $10,000. This, of course, benefits the government when you have an FHA loan, since the loan is secured by FHA. Also, you now pay more FHA fees (it was a lot cheaper in 2008!), thus shoring up the fund.
posted by wierdo at 3:50 PM on August 29, 2012

Response by poster: OK, now I get that Wells getting some interest is better than Wells getting no interest. I guess that didn't occur to me because I figured we were going to be unable to get a new mortgage somewhere else, but apparently it's pretty easy to refinance an underwater investment property with bad debt:income ratios as long as it's FHA. Cool.

wierdo: which FHA fees are you talking about? My upfront MIP is practically nil (like, 23 bucks) and my monthly MIP is almost exactly the same ($108.17 vs. $108.22).
posted by rabbitrabbit at 4:16 PM on August 29, 2012

Response by poster: Never mind, I see what you're talking about now, but that's for new FHA mortgages. If you scroll to the bottom you see the MIP for streamline refinances is lower for people whose original FHA mortgages were originated before May 2009 and refi'ed after June 11, 2012.
posted by rabbitrabbit at 4:35 PM on August 29, 2012

Response by poster: Also (sorry, distracted at work): THANK YOU EVERYBODY for helping me understand the reasoning behind this refinance. Much appreciated.
posted by rabbitrabbit at 4:57 PM on August 29, 2012

I just went through a similar process with Quicken loans; in addition to a lower rate I changed from a 30 year to a 15 year note which meant that although my payments went up some the total interest I will pay went down a lot. And they approached me with this deal about six months after the original mortgage closed. It wouldn't have made sense for me to refinance so soon after closing, the above arguments about not going to a competitor don't seem to apply in my case. I had the same question you did, and a possible answer I came up with is that Quicken had sold the loan (to Fannie or Freddie, I forget which) and that is how they make their money. By writing me another loan and presumably selling that one as well they get to make another quick profit. They do continue to service the loans after they sell them. I also assume the mortgage broker got a second commission off the deal as well, giving him an incentive to sell me a new loan. If my theory is wrong I hope one of the more knowledgeable people here will correct me.
posted by TedW at 10:10 AM on August 30, 2012

On reading Mullac's answer more carefully, I see he is giving a (better) version of my theory. But in my case the idea that they are preventing me from going with someone else still doesn't make sense, so I feel there must be additional reasons for them to encourage me to refinance.
posted by TedW at 10:17 AM on August 30, 2012

rabbitrabbit: "Never mind, I see what you're talking about now, but that's for new FHA mortgages. If you scroll to the bottom you see the MIP for streamline refinances is lower for people whose original FHA mortgages were originated before May 2009 and refi'ed after June 11, 2012."

Oh, hah, I didn't see that there was an exception to the new fees. For a while there wasn't, which I found a little dumb if the intent was to encourage people to refi into lower payments.
posted by wierdo at 10:23 AM on August 30, 2012

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