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I can't figure out why banks would actively try to get their customers to refinance their mortgage at a lower interest rate. And to be absolutely clear, I am talking about a bank refinancing a loan at their own bank (Wells Fargo refinancing a loan from Wells Fargo). What are their incentives?

I can think of only two:

  • They make some money from the closing costs
  • It resets the amortization schedule so you are paying a higher percentage of your payment as interest

But the difference isn't much when you may have only had the previous loan for a few years. And what's really confusing is that banks in the US right now are offering refinancing with no closing costs.

I would love to take advantage of one of these no-cost closing refinances but I'm afraid that I must be missing something big if the banks are trying to save me money. The crazy thing is that I can refinance my 30 year (of which I have 27 years to go) into a 20 year at a lower interest rate and pay almost the same amount per month. What am I missing?

This is a 30 year $402k fixed at 4.875% with 27 years left refinanced to 20 year fixed at 4.125%. Monthly payment goes from $2,206.80 to $2,474.74. How is this a good deal for Wells Fargo?

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8 Answers 8

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In a lot of cases, the bank has already made their money. Shortly after you get your mortgage is sold to investors though the bank is still servicing it for a fee. Therefore, if you refinance, they get to sell it again.

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    This is most likely the case. That, and making it more attractive to refinance with them that you taking your business to another bank.
    – KeithB
    Jul 27, 2011 at 15:51
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    So if I have a mortage of $200 K, the Bank sells this to investor. Over a Year I pay off 20K, bulk of it would go to Investor and a small fee to the Bank. Then I refinance $180 K, and Bank would sell this again??. What happened to original investor? I don't think it works the way you are explaining.
    – Dheer
    Jul 28, 2011 at 3:49
  • Yes, the bank would sell it again. The original investor would have received their interest (remember how front-loaded the interest is) plus their princinpal back and they do it again.
    – Jonathan
    Jul 28, 2011 at 4:36
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    Without refinance, the Bank can still pay the original investor [their balance money and interest is already paid], and sell it again to someone else. How does refinancing help sell again.
    – Dheer
    Jul 28, 2011 at 9:08
  • The original investor gets their capital back, having made a profit, and can reinvest that capital elsewhere. Just as you can pay off a loan, the bank gets their money back having made a profit, and can lend it out elsewhere.
    – keshlam
    Apr 25 at 0:59
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The big one is to keep you from refinancing it with someone else to get a better rate.

There may also be some funny-money reasons having to do with being able to count this as a new sale.

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It can be a good thing for the bank to refinance your loan for you - since you will be keeping the loan at that particular institution. This gives them more time to enjoy the free money you pay them in interest for the remaining life of the loan.

Banks that offer "No closing costs" are betting that mortgage payers will move their mortgage to get the lower interest rates - and whomever holds the loan, gets the interest payments.

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  • That and also the fact that the loan tenure is reduced. From a Banks point of view they are getting their money back early and its a good sign.
    – Dheer
    Jul 28, 2011 at 3:51
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1- Wells Fargo does not own our current mortgage. They have bundled it and sold it as an investment. 2- They make their money from 'servicing' the loan. Even if they only get $50 per month to service it (3% of our monthly payment), that adds up to $50,000,000 per month if they have a million homes under management. That is $600 million per year for each million homes being serviced 3- Managing the escrow gets them additional profit, because they can invest it and earn 2-3%. If 1,000,000 homes have an average balance of $2,000 in their escrow accounts, they can earn up to $60 per year, or $60,000,000 annually. 4- They make $1,000 every time they refinance the home. This is the approximate profit after paying real closing costs. Refinance those million homes, and you make a cool billion in profit! 5- They also want to be sure that they keep us as a customer. By lowering our payment, they decrease the likelyhood that we will refinance with someone else, and we are less likely to default. (Not that they lose if we default, because they don't own the loan!) 6- they make additional profit by paying off the old loan (they don't own it… remember), then packaging and selling the new mortgage. Since they are selling it as a security, they sell for future value, meaning they sell our $200,000 loan for a valuation of $360,000. This means that they sell for $200,000 PLUS some fraction of the additional $160,000. Let's say they only want a 10% premium of the $360,000 valuation. That means they sell our $200,000 loan for $236,000. They pocket $36,000. If they make a million of these transactions every year, that is $36 billion dollars in profit

So… Wells fargo refinances one million homes every year, and they make:

$36,000,000,000 initial profit for selling the loan (with absolutely no risk!), plus $1,000,000,000 for doing the loan

$660,000,000 annually to service the loan (Very little risk, since it is being paid by the owner of the loan as a service fee)

If they can retain the loans for their entire life (keep us from refinancing with someone else…), they can make $19,800,000,000 (that is 19.8 billion dollars in servicing fees)

The profit they make in a refinance is much greater than the money then can make by holding the loan for 30 years.

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What are you missing? Volume. Bank of America is more than willing to refinance a loan from Wells Fargo as long as the loan is still profitable.

There are some caveats with that, though. For one, many land have penalties if they are paid off within two or three years.

Additionally, the fact that banks are offering to refinance at great rates doesn't mean that you'll be approved, or that you'll get those rates.

If you could post some actual numbers, we could help you see if it's a good deal to refi, and explain exactly where the bank expects it's profit.

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  • This is Wells Fargo refinancing a loan from Wells Fargo.
    – guidoism
    Jul 27, 2011 at 15:22
  • 30 year $402k fixed at 4.875% with 27 years left refinanced to 20 year fixed at 4.125%. Monthly payment goes from $2,206.80 to $2,474.74. How is this a good deal for Wells Fargo?
    – guidoism
    Jul 27, 2011 at 15:27
  • In this instance, refinancing is certainly better for you than keeping the current loan, assuming you can afford the extra monthly payment. By staying in the current loan, you will pay the bank an additional $306,000 in interest over the next 27 years, or an average of $944 per month in interest. On the other hand, after refinancing you will pay the bank $180,090 over the next 20 years, or an average of $750 in interest each month.
    – Benjamin Chambers
    Aug 8, 2011 at 2:25
  • As Jonathan said above, Wells probably sold your mortgage already anyway; if so, refinancing it allows them to make money by selling it a second time. Additionally, refinancing it themselves keeps you from refinancing it with a competitor.
    – Benjamin Chambers
    Aug 8, 2011 at 2:26
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Banks make money on load origination fees. The "points" you pay or closing costs are the primary benefit to the banks. A vast majority of the time risks associated with the mortgage are sold to another party.

FYI, the same is true with investment banks. In general, the transaction costs (which are ignored by modern finance theory) are the main thing running the incentives for the industry.

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The reason is the same as with cell phones payment plans. As competition grows cell phone companies offer better payment plans for the same price or the same plans for lower price or both so that you stay with that cell operator. Banks also make better offers if the financial situation allows.

Suppose several banks offer refinancing with better terms but prohibit refinancing loans from the same bank. Okay, you refinance from another bank and them maybe refinance the new loan again from the original bank - it's a new loan after the first refinance and prohibition no longer works. They just make you jump through more loops and it doesn't make sense neither for them nor for you

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It also reduces risk from the bank's eyes. Believe it or not, they do lose out when people don't pay on their mortgages. Take the big 3 (Wells, Chase and BoA). If they have 50 million mortgages between the 3 of them and 20% of people at one point won't be able to pay their mortgage due to loss of income or other factors, this presents a risk factor. Although interest payments are still good, reducing their principal and interest keeps them tied down for additional (or sometimes shorter) time, but now they are more likely to keep getting those payments. That's why credit cards back in 07 and 08 reduced limits for customers. The risk factor is huge now for these financial institutions. Do your research, sometimes a refi isn't the best option. Sometimes it is.

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