For more articles on the secondary
View these articles and more at
“Bad Timing Boosts Home-Loan Costs,”
“GSEs Remain in Full Gear,”
“Trends Signal a Potential
Liquidity Crisis Ahead,”
“Deal Out Your Loans,”
Tammy Butler is CEO of Fair Lending Diversity Inc., a strategy and training company. She is the youngest woman ever
to receive the Mortgage Banker Association’s highest designation of Master Certified Mortgage Banker (CMB) and is
a 1983 graduate of the University of Maryland, College Park.
Connect with Butler on LinkedIn. Reach her at
The Secrets of Mortgage Pricing
Learning the language of the secondary market is still important
By Tammy Butler
For many originators today, mortgage pricing has always been automated and presented to them by their company’s pricing engine. Older originators may remember the days
when lines of fax machines pumped out rate sheets all
day, and they had to figure out pricing for themselves.
Not only did this take a lot of time, but it resulted in a
lot of errors. Whichever world you come from, understanding how mortgage pricing gets created is an
important skill to learn.
Basic mortgage jargon can take years for novices to
understand. Understanding how pricing works makes
that learning curve even steeper. It is another language and one that is not easily grasped.
Not understanding the language and concepts can
cost you deals, however. The ability to discuss pricing
structures also is important for making the right decision when interviewing with prospective employers.
Where money comes from
Mortgage companies do not manufacture money
because they are not depositories. They don’t have
customers opening up checking and savings accounts
or adding money to certificates of deposit. Their business model is to set up a warehouse line from which
they can fund their mortgage closings.
This warehouse line comes from a bank and works
like a credit line. The company funds a mortgage loan,
an investor buys the loan after closing, which then
pays back the warehouse line so the next mortgage
can be funded. This cycle can occur hundreds of time
Financial institutions that accept depositor funds,
like banks, may have varying models for funding mortgage loans. One option is to use the funds of depositors and offer mortgages or other loans to consumers
or other institutions.
When those loans get paid back, they produce profit
for the bank in the form of interest. If a bank pays
depositors 1 percent on their deposits, for example,
and the interest the bank collects on a mortgage
is 4 percent, this leaves the bank with a 3 percent
spread, or income stream.
Another option exercised by banks is to borrow
money from the Federal Reserve. The “cost of funds”
index is the rate at which financial institutions can
borrow money. Banks can borrow at that rate and
offer money to consumers or other entities at a
higher interest rate to make a profit on the difference
between the two rates. Banks even may make use of
both models at once. Large banking institutions like
Citibank, Chase Bank, Wells Fargo and Bank of America
use these models and more to make a profit.
Secondary markets are the money people that purchase loans from mortgage companies. They do not
deal with borrowers directly, but they do want to
make money from the transaction and are willing to
take on the risk of the borrower paying them back.
Whereas primary market people — banks that do not
carry the debt and mortgage companies — want to
work directly with borrowers, but do not want to take
on the risk associated with those borrowers paying
There are many secondary market players. These
secondary market players include Fannie Mae and
Freddie Mac — the government-sponsored enterprises — as well as pension funds, insurance companies
and many others. Some lenders, like the big banks, are
both primary and secondary market players.
Obviously, in a two-tiered system like this, compa-
nies in both tiers need to make a profit or the whole
system will collapse. The important piece of this profit
puzzle is margins, an age-old concept used in numer-
ous industries. The use of margins in the mortgage
industry, however, can get incredibly complex. Before
we dive into the topic, it is important to understand
some basic terms.
■ ■ Price: This is the percent of the loan amount that
investors are willing to purchase. A price of 100
means the investor will pay 100 percent of the loan
amount. If the mortgage company wants to make a
profit on the loan, they must charge a higher price
to the consumer than what the secondary market
is willing to pay for that loan, or charge borrowers
points to make up the difference. Most borrowers
do not want to pay points, so mortgage companies
typically raise the interest rate offered. (Note: this is
how companies mark up the pricing, not how mortgage originators should mark up the pricing.)
■ ■ Raw price: This is the price that investors are willing to pay for a loan. Typically, they offer a price (as
above) along with an associated interest rate. This
is called the raw price instead of price because it
denotes the starting point before any mark-ups or
mark-downs are made to a company’s distribution
■ ■Basis points (bps): This is a common unit
of measure for interest rates. It is equal to one
one-hundredth of one percentage point.
■ ■ Par pricing: Pricing is measured on a scale with
par equaling 100. At par a lender pays no money
and makes no money. When originators offer borrowers par price for their loans, the borrowers pay
no points — with one point equaling 1 percent
of the loan amount — and get no lender credit. If
mortgage companies have raw par pricing from
investors, they must mark up the pricing by increasing the interest rate to make a profit before they
offer par pricing to borrowers.
■ ■ Above par pricing: This is anything above 100. A
price of 101 would be 1 percent of the loan amount
above par. If a lender is offered above-par pricing, then the investor is willing to pay the lender a
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