Tuesday, January 25, 2011

Mortgage Lending

Mortgage lending can be quite a profitable business.  Based on recent earnings, the amount of interest income is three to four times that of their actual interest expense.  So for every .30$ spent in interest expense for example it produces $1 in interest income.  Not a bad model at all.

We need banks, don't get me wrong.  Without some ability to form credit most of us would be living in an apartment and not a home.  So in the good times, banks are very profitable but just like with trading risk management is key.

I was doing a back of the envelope calculation to see at what points do defaults wipe out earnings from the vast majority of conforming loans.

I assumed a $200,000 mortgage, 5% 30 year fixed rate, a recovery of 40% on defaulted credits (would include the expense of foreclosing as well).

It only takes about a 9% default rate to wipe out the net interest revenue of the other 91% that conform.  


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