In the increasingly competitive mortgage lending market, every basis point of profitability counts. According to the Mortgage Bankers Association, the average profit earned per loan originated in 2018 was only $367, a decrease from $711 per loan in 2017. Many depository institutions employ an originate-and-sell model for a sizable portion of their mortgage lending operations, in which production is sold to investors like Fannie Mae and Freddie Mac.
Like any business, a mortgage lender must appropriately price its products to be profitable. Just as your local supermarket prices the inventory it purchases from vendors according to a targeted margin, a mortgage lender must price its interest rate locks according to a targeted margin. When a lender extends an interest rate lock commitment, it essentially “purchases” (on a probability weighted basis to account for potential fallout) the “inventory” that it will eventually sell in the secondary market. But unlike your local supermarket, a mortgage lender’s final selling price will vary with interest rates over the loan’s “shelf life” of about 30 days, the average time period from the rate lock extension until sale.
At the time of lock, the margin of the loan depends on (1) the investor’s current commitment price for the loan product and (2) the buy price of the loan. The difference between the two is called the locked margin.