The mortgage industry evolved after the Second World War. As the U.S. population grew, so did the demand for housing. The vast majority of homebuyers lacked the funds to buy a home for cash, so they financed that purchase by using a financial instrument known as a mortgage.

Initially, most mortgages were made by Savings & Loans. These were institutions specifically chartered to serve the average American as a place to save and secure loans. That changed in the 80’s when the “savings & loan crisis” hit and banks and mortgage banks stepped to the front of the home lending scene.

From the 80’s until just last year, the mortgage industry was operating “pretty much the same.” Some set their rates a little higher, some a little lower. It was common practice for a borrower to pay a 1.00% Loan Origination fee (and other assorted junk fees) in order to obtain a mortgage.

The years 2007-2009 saw the blow-up of the financial system as we knew it. In response to that, two U.S. Legislators, Barney Frank and Christopher Dodd wrote “The Financial Reform Act for America” – more commonly known as the Dodd-Frank Act. That act set up certain regulations which went into effect in January of 2014. One of those regulations, called the “3% Cap Rule,” put a concrete limit on how much a lender can charge you to obtain a “Qualified Mortgage.” This 3% Cap is the maximum amount that can be earned by a lender in “disclosed fees.” That does not mean that all lenders have the same interest rates!

Interest rates and loan fees are two separate and distinct aspects of a mortgage loan. In a simple explanation, interest rates are set daily (or hourly) by entities in the secondary mortgage market – FNMA, FHLMC, FNMA, etc. These entities establish a “Par Rate” for the day which they publish to all lenders nationwide. That’s where the differences between lenders starts!

This published ‘par rate’ includes a fee for servicing the loan, called the “Service Release Premium” or SRP. From that par rate, a lender can take their rate down, thereby reducing their SRP income, or they can increase the rate, giving them more income from their SRP. This income from SRP is “non-disclosed income” which borrowers never see and it is not included in the 3% Cap rule. Is there such a thing as a “true NO Fee Mortgage”? And if so, how is that made up? Let’s take a look. Let’s suppose that a loan was made today at a 4% interest rate. In rough numbers, the end investor will end up getting a 3.50% return on their capital. The other .50% will go to the Servicer of the loan and so that Servicer will make .50% of interest monthly for collecting the payment from the borrower and dispersing the funds.

A “true No Fee Mortgage,” in this example, would bear an interest rate at the daily par rate of 4% – and there would be No Fees for the loan. This would typically be the case if you were doing the loan with a Mortgage Broker. This is because a Mortgage Broker “CAN NOT” earn any undisclosed income. And a Broker cannot earn income from two sources, such as from the lender and from a borrower. A Mortgage Broker will normally charge No Fees to the borrower, but they will get a check from Title at closing. Brokers earn their income the same way that Real Estate Brokers are paid their commissions – with a check from Title after closing. The Broker receives their compensation from the lender that they broker the loan to – and charge nothing to a borrower.

Banks and Mortgage Bankers are commonly still charging origination fees for their loan products. So, go back to our example. Let’s say that the same loan we discussed above, at an interest rate of 4% was being made by a Mortgage Banker and that Mortgage Banker was charging a 1.00% Origination Fee and $900 in processing/underwriting/junk fees. Could that lender also create a No Fee mortgage? The answer is “yes!” They can create a No Fee mortgage by increasing the interest rate – a practice called “Premium Yield,” which means that the Loan Servicer, the entity that you pay your monthly payment to, earns extra income (premium) when they collect your loan payment. This premium income is generated because the end investor (in our example) is going to still earn the same 3.50% return. But now, the Servicer is earning extra premium interest due to the higher interest rate.

If that same loan is now made as a No Fee with an interest rate of 4.25% – then the servicer earns .75% monthly interest from that loan. Because of this .25% increase in monthly income, the Servicer will pay a “Premium SRP” to the originating lender. This premium payment gets the Mortgage Banker back their Origination Fee plus any junk fees. But no one ever sees this because SRP is “undisclosed income.”

How do you know if your buyer is getting the best deal on their loan? Simple – the next time that you get a loan estimate from your Loan Officer, ask them for a “Rate” that has “No Fees.” Then get a No Fee quote from another lender. By using this technique, you’ll be comparing apples-to-apples. Then, “it’s all about that rate.”