How do banks fund mortgages?

Although banks and other lenders earn a considerable amount in interest and fees from the loans they give out, they usually need to raise funds externally if they don’t have much by way of customer deposits.  

Until the Global Financial Crisis of 2008, mortgages were considered a fairly risk-free debt from the lender’s perspective and could be “securitised”, or packaged and traded, in large volumes. However, lenders trying to protect the value of mortgage-backed securities ask borrowers to pay Lender’s Mortgage Insurance (LMI) on loans that amount to more than 80 per cent of the property’s market value. In turn, this has resulted in the standard practice of asking borrowers for a minimum of 20 per cent as the deposit if they don’t want to pay LMI. 

Securitisation of mortgages now brings in the smallest share of banks’ funds, with lenders also borrowing from either the government or other financial institutions. When lenders need to borrow money, they are also assessed for risk in the same way mortgage applicants are scrutinised.  

Larger banks, which have more access to customer savings, tend to find it easier to borrow than lenders with smaller deposits. Some banks also have the advantage of leveraging their equity when seeking funds through the share market. They may put up some of the equity for sale and raise the required sum of money.

Suppose you approach a lender for a home loan, but the lender is not a deposit-taking institution. It may insead be borrowing from other institutions, which would require repayment along with interest due on the sum. They would need to recoup some of these costs, which they might do by charging you more interest or fees. 

On the other hand, a lender with more assets and alternative funding may offer more competitive interest rates and fees, to attract a variety of borrowers. Lenders can also try to minimise the chances of loan defaults by being selective about the kind of properties they approve loans for.  

If the bank or lender is not privately owned, you could look up information about their shareholding and sources of funding, if only to confirm that they may indeed offer cheaper mortgages. This may be worthwhile if you are looking to prioritise a bank or lender that invests ethically.

As a borrower, it may be worth comparing not just lenders’ interest rates and fees, but their funding and investment choices, to ensure that you get a suitable home loan for the desired property.