How Banks make Money on Loans

Video Transcript

"Okay, you have mentioned at the beginning, that actually there are some things that these people in the industry don't want us to know. What are those? Okay, I said we have gone over the basics of what the banks, the brokers and everybody looks at and we have talked about the different loan programs. Now the things that we haven't discuss are how they come up with your interest rate, and how they get paid. Okay, those are the two main areas that people are unsure of. So first we are going to talk about interest rate. Now everyone says, I have people come to me, I don't know how many dozen times and said, hey the federal reserved lowered the interest rate today I want a lower interest rate. Or I heard on the TV the interest rates are five point eight-seven five percent, I want that interest rate. It doesn't work like that. First we will talk about the federal reserve. The federal reserve, does not set their mortgage interest rates, they set your bank to bank lending rates. Alright? Which are the percentages between the banks, alright? With that, that will have an impact typically on your home equity lines of credit and things of that nature that are supported by the federal reserve. So if you hear the federal reserve lowered interest rates, that doesn't mean interest rates went down. Okay. The other thing you need to know is when you hear publish on TV, thirty years fixed loan today is five point eight-seven five. Okay, with that what they are talking about is typically APR rate, with the most ideal situation; all of these being at their best. And with APR rate, what they are saying is what the banks will lend out on an average without charging anything extra to the brokers or charging anything extra to the buyers, this is called a APR interest rate. And we are going to use for an example, per interest rate at six percent. Okay, when you go to a bank or broker, they can give your this per interest rate at six percent where they don't have to pay the bank extra and they are not getting paid by the bank, it is called PAR which is even across the board or well notate that with a zero. Okay, now at this rate you are still going to be responsible with your closing costs. Okay, which are your appraisal, your prepaid interest, your taxes, true closing cost cover your escrow fees and cover any points charged by the broker. Now, if we want lower than a six percent interest rate, we can go lower than a six percent interest rate. We are going to go, well say to a five point five percent interest rate. Now, the market varies so I can't tell you exactly where it would be, but this is going to a cost us so we are going to pay what are called discount points to get this lower interest rate. Which is the bank knows that they are giving you the money for less so they are going to charge some of what they would normally make up front. So we will go down five and half percent and we have to pay discount points, we will say this is one point. Now a point is equivalent to one percent of your loan amount. And then we will say now we don't want discount, we don't want to pay discount points and we actually don't want to pay PAR, we want to get paid back. We can get what is called Yield Spread Premium. Now Yield Spread Premium or YSP is when the bank pays us. Now this is an area, we will say we will go to six and half percent, the bank will actually pay us money for giving you a high interest rate because now they are making more than average or typical. So this is where they will give us one point, this is just an example an illustration. Now in this illustration, if we do it at PAR we get a six percent interest rate, if we do a below PAR at five and half percent, we pay a point and if do above PAR we get what is called Yield Spread Premium, well say six and half percent, we are giving a point back to the bank. Now this is a place, a mortgage broker has unfortunately taken advantage of clients for many years and they said okay, we need to put you at a six and half percent interest rate but didn't tell their clients they were getting paid for that, so they still charged their clients all of the normal fees and they were getting money back from the bank for selling a high interest rate. This is something you need to be aware of and you need to ask your broker or ask your bank directly. By a law brokers are suppose to disclose this, by a law banks don't have to disclose it if you are going to a direct lender. So these are important questions you have to ask. Okay, so that is how your interest rate is determined, it is determined off those four main columns we talked about before and then it is determined off what you want to pay or what you want to get back."