Let the Fees Begin

We have already determined that the yield investor buys a mortgage backed security with a guaranteed pass through interest rate. In the last posting, I told you where to find that pricing. Here is the next step.

If your mortgage is pooled with and backs one of these mortgage backed securities, you will have to pay more than the security pass through rate that the investor receives. That is because of two reasons:

Someone has to service your mortgage and handle all of the accounting related to the servicing of the security pass throughs to the investor
The lender who makes your mortgage wants to recoup the cost of that servicing, and make a profit

As a rule of thumb, the rate that you will pay on your mortgage will be higher than the corresponding security pass through rate by

• .50% on an FHA or VA loan – a GNMA security
• .45% on a conventional mortgage – a FNMA security

If the investinginbonds.com daily price sheet shows that a 4.5% security pass through rate is paying 100.875%, that means the mortgages that back that security – maybe yours - will average about:

• 5% for FHA and VA mortgages
• 4.95% for conventional mortgage

Also, as a rule of thumb, the value of that markup above the security pass through rate is equal to about 2.75% for an FHA or VA mortgage and 1.5% for a conventional mortgage. Those are simply the net present value of the anticipated collection of those mark ups collected over the life of the mortgage.

Let’s recap how your lender is doing so far. I will use an FHA loan for this example.

• Your lender makes you a loan at 5%
• Your lender puts your loan in a GNMA mortgage backed security with a 4.5% pass through rate
• The 4.5% GNMA security with a 4.5% pass through is selling for 100.875% according to investinginbonds.com
• Your lender sells the security at 100.875% and makes a profit of .875%. We will call this trading profit

Your lender realizes a 2.75% gain from the markup above the security pass through rate – the difference between your 5% mortgage and the 4.5% security pass through rate. I will call this the MSR profit – the mortgage servicing rights profit.

So far, your lender has made 3.625% (of your mortgage balance) through the origination of your mortgage. The math on that is .875% plus 2.75%. If it had been a conventional loan, the profit would be 2.375% - .875% plus 1.5% for the rate markup. On a $200K mortgage, that’s $7,300 for the FHA loan and $4,750 for the conventional loan.

Before I close this posting, it is important to note that a lender could originate a mortgage that is placed in a security that is trading at less than 100. Look back at the previous posting. The GNMA 3.5% security pass through is trading at 94 2/8/32 or 98.875. If the lender makes you a 4% FHA mortgage - .5% above the security coupon – and creates a 3.% security, they will realize a trading loss of 1.125% (100% - 98.875%) and rather than being at a profit of 3.625%, they will be at a profit of 1.625% ( minus 1.125% plus 2.75%). They make up the difference by charging discount fees, which I will discuss in the next posting.

We’re not done yet. So keep your eye out for my next post – there’s more!