There are many reasons why banks actively seek to refinance mortgages, but profit levels and fee income are among the primary reasons. Banks make money by borrowing money from bank deposits or the Federal Reserve and lending that money to loan customers at a higher rate of interest than it cost the bank to borrow. To remain profitable, banks must make loans, including refinances, on an ongoing basis.
Fees And Interest
Homeowners typically pay an origination fee to refinance a mortgage. This fee incorporates a number of loan-related costs, such as document preparation fees, but it also serves as a processing fee that translates into profits for the bank. Additionally, banks make larger sums of money on interest payments over long periods of time. Someone with 15 years left on a mortgage paying 6 percent interest would actually help the bank make larger long-term profits by refinancing into a new 30-year loan even at a lower rate of interest. The additional years more than make up for the lower rate.
When homeowners default on a mortgage, the lender forecloses and attempts to sell the home to raise sufficient funds to cover the amount of the outstanding loan. Lenders that write home equity lines or loans that sit in second lien position behind the mortgage have less chance of settling a debt through a foreclosure sale than the lender in first lien position. Therefore, lenders in second lien position benefit by refinancing the first and second liens into one new loan.
Homeowners with variable rate loans that reset at higher interest rates often have trouble making monthly payments. Additionally, people who become unemployed or experience health problems sometimes fall behind on loan payments. Banks can foreclose on these people, but that process takes time and leads to significant legal expenses. Workout loans, which involve banks renegotiating loan terms, result in lower interest rates and reduced monthly payments. While this means less profit for the bank, lenders often view workout loans as the lesser of two evils when compared with foreclosures.
Bank loan officers and mortgage originators are paid sales commissions, and some of them have pay packages that are entirely commission-based. Banks pay these commissions by giving loan officers a share of the origination fee or a percentage of the loan portfolio profits. Loan officers must meet sales goals both to keep their jobs and to generate income for themselves. Mortgage refinances often are quicker to process than purchases, because the homeowner does not have to find a home. Therefore, loan officers often are keen on offering mortgage refinances to both new and existing bank customers.