When looking at a bank’s rate sheet, you’ll notice a base rate, which is the lender’s starting price before any adjustments. Then come Loan-Level Price Adjustments (LLPAs), which add or subtract basis points based on risk factors such as credit score, loan-to-value (LTV) ratio, debt to income ratio, and property type. These are set by Fannie Mae and Freddie Mac under FHFA regulation for conforming loans. Note that FHA, VA, and USDA loans have different rate structures and don’t use Fannie/Freddie LLPAs.

Now, let’s explain how lenders determine their base rate. Lenders usually sell their loans to investors in the secondary market, which is known as the Mortgage-Backed Securities (MBS). For example, if the rate at which an investor buys the mortgage is 4.5%, (this price fluctuates and mainly follows the 10-year yield, with an average margin of 1.5 to 2%). Added to that is the fee that Fannie or Freddie charges for guaranteeing the mortgage known as the guarantee fee (G-FEE) of about half a percent, bringing the total to 5%. On top of this, the servicer which is the company that handles statements and manages escrow, earns a servicing fee, around 0.25% (these numbers are for illusative purposes the actual amounts fluctuate), bringing the lender’s total rate to about 5.25%.

Even with this breakdown, it’s still not clear where lenders make their profit. That’s where rates from different lenders come in. Referred to as the lender’s margin, if the market rate for the loan is 4.5% (for a total of 5.25%), the lender will offer you a Premium Rate of 5.5%. This quarter-point difference is profitable for the lender due to the higher interest revenue. When a lender sells a $400,000 loan to an investor at a higher rate, they are compensated for that through the higher sale price. For example, the investor might pay $406,000 for a $400,000 loan because of the elevated rate.

Lenders vs Brokers

There’s a common saying in the mortgage industry: “Brokers are Better.” This is because brokers often have advantages over retail lenders, allowing them to offer lower rates. A retail lender can have higher rates are due to high overhead costs such as employing loan officers, marketing expenses, and maintaining local branches. Brokers, A. work with wholesale lenders who don’t have these added expenses, and B. Brokers work with multiple wholesale lenders, shopping around to find the lowest rates, whereas lenders offer only their own rates. It’s important to know what the broker’s fee is. While a broker might say they’re paid by the lender, this fee can is embedded in your rate. As noted earlier, a higher rate has a dollar value, so if a broker charges a higher rate, it effectively includes a broker’s fee.

Points and Lender Credits

When locking a rate, a lender or broker will tell you either:
A) The rate is a par rate, meaning no extra cost (points) or lender credit.
B) The rate includes a lender credit. As explained earlier, a higher rate is valuable because it means more interest paid, and this credit can be used to cover closing costs.
C) Points. A point is 1% of the loan amount. Borrowers can choose to buy down their rate for a fee. For an example one point (1%) of loan amount can buy down your rate by a quarter percent. Its important to calculate when your break even point is when buying down your rate. For example if it costs you $4,000 to buy down a rate that will save you $150 a month, your break even point is 26.6 months (4,000 /150)

APR vs. Interest Rate

The interest rate is just the borrowing cost; the Annual Percentage Rate (APR) includes fees and gives a fuller picture of total cost. When comparing rates you should compare the APR and not just the interest rate.