Why would a bank loan for a 30 year mortgage at 3.5-4.22% APR?

noob_trad3r · Dec 16, 2011

If the risk free return on a 30 year T-note is 2.93%

Wont it make more sense to borrow from the discount window at 0.2 and buy the 30 year not at 2.93% instead?

newwurldmn · Dec 16, 2011

Quote from noob_trad3r:

If the risk free return on a 30 year T-note is 2.93%

Wont it make more sense to borrow from the discount window at 0.2 and buy the 30 year not at 2.93% instead?

I am refi'ing this week and I am doing it via the Harp program. I am getting 4.5% and it's govt backed for the bank.
So they can borrow at .01% (what they pay on deposits) and lend to me at 4.5% (my rate).

Better than .2 and 2.93 and the same credit risk.

Daal · Dec 16, 2011

Quote from noob_trad3r:

If the risk free return on a 30 year T-note is 2.93%

Wont it make more sense to borrow from the discount window at 0.2 and buy the 30 year not at 2.93% instead?

People have to pay these monthly correct?If so, APR is a misleading number since it does not take into account some of the compounding the bank will have by reinvesting the payments. The true annual rate(effective rate) will be higher

piezoe · Dec 16, 2011

Banks, or who ever ends up with the mortgage bond, depend on mortgages rolling over on average every 7 years or so. Very few 30-yrs stay with the original borrower for 30 years.

If you know you will stay in your home for 30 years, and few do, you can hardly make a better investment than to take a 30 year fixed rate mortgage at low interest. You will end up, in effect, getting paid to use someone else's money. If you are in that situation and you find inflation is running higher than you APR never accelerate payments on the principle.

itsame · Dec 16, 2011

Quote from noob_trad3r:

If the risk free return on a 30 year T-note is 2.93%

Wont it make more sense to borrow from the discount window at 0.2 and buy the 30 year not at 2.93% instead?

1. This would be a mismatch in terms of matching long term assets with short term liabilities. Companies (not just banks) that do this are setting themselves up for a world of hurt.

2. This is a common misconception among the public. Banks DO NOT borrow at the discount window. The discount window is for exceptions (such as the recent credit crisis) and are very short term loans. They also carry a very high penalty interest rate.

3. The discount rate right now is 75 basis points.

4. Banks borrow money at the federal funds rate (from other banks) which is currently around 20 basis points

Swan Noir · Dec 16, 2011

Exactly. The banks know the average maturity on the paper is well under 10 years so that is their benchmark. In addition there is a certain amount of fee income to be generated and, of prime importance, is that they know the mortgagee tends to maintain a broad deposit, loan etc. relationship with them.

And when rates go up they intend to package an entire new round of high yield paper, including sub prime, to sell to Wall Street. The buzzer may go off and the bumper cars may stop but bankers know that after a short period the ride restarts following a whole new round of ticket sales.

Piezoe is also correct about it being the best loan you'll ever see if you do not prepay. Even if there is a depression the likelihood of it being followed by rapid inflation is so high that being long the hard asset and short the paper is a very good bet.

Quote from piezoe:

Banks, or who ever ends up with the mortgage bond, depend on mortgages rolling over on average every 7 years or so. Very few 30-yrs stay with the original borrower for 30 years.

If you know you will stay in your home for 30 years, and few do, you can hardly make a better investment than to take a 30 year fixed rate mortgage. You will end up, in effect, getting paid to use someone else's money.

Robert Weinstein · Dec 16, 2011

Quote from Daal:

People have to pay these monthly correct?If so, APR is a misleading number since it does not take into account some of the compounding the bank will have by reinvesting the payments. The true annual rate(effective rate) will be higher

If I understand your statement correctly you are not understanding how interest is charged. putting aside "APR" which is a reflection of the interest rate plus some of the charges to get a loan (meant to allow consumers to easily compare one loan with another).

The interest charged is based on the current amount owed during any given month. This is why your payment increasingly goes towards the principal more and more each month and less and less towards interest.

To answer the OPs original question, Banks are not lending money for 30 years with a 30 year mortgage. They know (and now so do you) that the average 30 yr loan only lasts for about 8 years. Add in all the fees etc... they collect and its a nice little system they have going for them.

Daal · Dec 16, 2011

Quote from Robert Weinstein:

If I understand your statement correctly you are not understanding how interest is charged. putting aside "APR" which is a reflection of the interest rate plus some of the charges to get a loan (meant to allow consumers to easily compare one loan with another).

The interest charged is based on the current amount owed during any given month. This is why your payment increasingly goes towards the principal more and more each month and less and less towards interest.

To answer the OPs original question, Banks are not lending money for 30 years with a 30 year mortgage. They know (and now so do you) that the average 30 yr loan only lasts for about 8 years. Add in all the fees etc... they collect and its a nice little system they have going for them.

What I mean is that a 4% APR actually produces a higher economical return over the long-run than 4% a year given that the bank can reinvest the payments in other investments in a monthly basis
APR ignores the effect of compounding. This favors the banks at the expense of the people. Its amazing that this 'metric' is endorsed by the Truth In Lending Act

Its state sponsored ignorance

Daal · Dec 16, 2011

A 4% APR actually costs a person 4.03%, might not seem like a lot but over the long-run it adds up. In the case of credit card loans the differences get to obscene levels