How do banks make money on mortgages?

Most banks in Australia are commercial, profit-making entities that make money by offering financial products and services. However, customers have a more complex relationship with banks than, for instance, a grocer from whom they buy meats or fruits. Often, people apply for a mortgage with the same institution where they’ve already opened a bank account, given their familiarity with the bank. Interest and fees charged on the mortgage are likely to be more than the interest paid to a savings account customer, resulting in a net profit for the bank.

In what ways do banks make money on mortgages?

When banks assess mortgage applications, they try to confirm that the borrower will repay the money within the expected time. While they may not always reject an application from a risky borrower who may default or fail to repay the loan, they may charge that person more in interest or ask them to pay for Lender’s Mortgage Insurance (LMI) to help cover the lender's risk. In either case, the bank sets the interest and fees for mortgages to ensure it makes some money out of the transaction. Also, when customers refinance their loans to save on interest, they may end up paying some fees to their original lender as well. 

The different mortgage-related fees paid by customers can include an application fee, which is paid at the time of signing the mortgage, and periodic maintenance fees. Some banks may offer a mortgage product package with a flat annual fee rather than fees for different phases of the mortgage. Also, they may charge customers fees when they choose to switch the mortgage conditions, such as switching to interest-only repayments or a fixed rate for a few years.

How does a low mortgage interest rate help banks make money?

Since mortgages involve borrowing a significant amount of money which is usually repaid over decades, banks often like to sell as many mortgage products as possible. This results in competition between banks for signing up borrowers, with lower interest rates likely to attract more customers. Banks also compete for customer deposits, which give them the money to lend to borrowers, so they select their interest rates to ensure they remain competitive in both respects. Another factor for banks to consider is that customers may not think of switching to a bank offering a higher interest rate on a savings account as much as they think of refinancing a mortgage to get a better interest rate.

Interest rates are also dependent on other factors, such as the Reserve Bank of Australia’s (RBA's) cash rate. At present, since the cash rate is at a historically low level, mortgage rates are also fairly low - as are savings account interest rates. Learning more about how the cash rate affects a bank’s lending and deposit rates may help you better understand how you can minimise the amount you pay to a bank when taking out a mortgage. 

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