Why You're Spending Too Much on Your Mortgage

With millions of homeowners underwater on their mortgages, not everyone has been able to take advantage of the rock-bottom rates on home loans. But for those who have been able to refinance, low rates have proven to be extremely useful, slashing monthly mortgage payments and freeing up valuable cash to spend on other needs.

Yet as much as some homeowners have been able to save on their mortgages, some believe that they should be paying even less than they are currently. The reason has to do with an obscure relationship between home-loan rates and the mortgage-backed securities market, but the result is that homeowners may be missing out -- while lenders book better profits than they deserve.

Why mortgage-backed bonds matter
It's hard to complain about where mortgage rates are right now. Currently, 30-year rates are below 4% after having come close to the 7% mark as recently as mid-2007. Enterprising homeowners have had many opportunities to lock in lower rates, and some have actually refinanced on multiple occasions in recent years.

But with the Federal Reserve doing everything it can to keep rates low, some believe that not all of the Fed's efforts are making it through to homeowners. A recent Wall Street Journal article explained how the mortgage-backed bond market has seen even sharper drops than retail mortgage rates.

Here's how it works: Most banks that offer mortgage loans end up selling them to entities like Fannie Mae and Freddie Mac, which then package them with similar loans to create mortgage-backed securities. Lately, demand for those securities has been red-hot, as investors snap up shares of mortgage REITsAnnaly Capital (NYS: NLY) and American Capital Agency (NAS: AGNC) , which in turn buy those bonds. That has pushed the interest rates investors are willing to accept on those bonds way down -- further down, in fact, than the rates homeowners pay have dropped.

The spread between what borrowers pay and what investors accept represents profit for banks and other intermediaries. With that spread at roughly twice its normal level, money that would otherwise go to homeowners -- or to the mortgage REITs -- is getting siphoned off by those intermediaries. And even though the amounts involved aren't huge -- half a percentage point amounts to less than $100 per month on a $350,000 mortgage -- they are significant in the aggregate.

Who's profiting?
Banks and mortgage lenders can certainly argue that anything extra they're getting from mortgage refinancings now is fair compensation for the losses they've suffered in the recent past. With Wells Fargo (NYS: WFC) , Bank of America (NYS: BAC) , and JPMorgan Chase (NYS: JPM) among the participants in the recent $26 billion settlement of questionable foreclosure practices, they're clearly interested in whatever ways they can find to recoup lost profits and boost their financial health.

But in my view, this is simply another example of how the housing-related markets aren't functioning the way they should. Just as government refinancing programs took away the focus from the true problem of underwater mortgages forcing people to stay put when they'd prefer to sell out and start over, so too are divergent trends in the primary mortgage industry versus the mortgage-securities market creating some undesirable results.

What to do
From your perspective as a homeowner, what this means is that it's more important than ever to shop around to try to find the best deals. One criticism has been that large institutions have priced smaller banks and mortgage lenders out of the market, using economies of scale to build market share. But even as lending standards have gotten tighter, you need to remember that refinancing still represents a very profitable opportunity for your lender -- one in which you should share the benefits.

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At the time thisarticle was published Fool contributor Dan Caplinger cut his mortgage costs to the bone awhile back. You can follow him on Twitter here. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Bank of America, Wells Fargo, JPMorgan Chase, and Annaly Capital, and has created a covered strangle position on Wells Fargo. Motley Fool newsletter services have recommended buying shares of Annaly Capital. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy puts a roof over your head.

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