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> After all, they've presumably backed your loan with some kind of equally long-term security. See, this is what banks are explicitly NOT in the business of do

> After all, they've presumably backed your loan with some kind of equally long-term security. See, this is what banks are explicitly NOT in the business of doing. They are in the business of borrowing short and lending long, with a rate spread to make money in the process. I have had a number of mortgages in the last 10 years in the US (refinanced multiple times), and none of them had any prepayment penalties. I suspect if I looked for one that does I might find it and it might have a slightly lower rate. Maybe. That depends on whether the bank planned to keep it on the books or sell it on; it's easier to sell on standardized mortgages into an MBS than weird ones with bespoke terms.

caf 7y ago
They are in the business of borrowing short and lending long, with a rate spread to make money in the process. See that makes sense with variable rates. However if you offer a 30-year fixed rate at 4% because you know that you can currently borrow short at 2.5%, what happens in 20 years time when no-one is willing to lend short to you for less than 6%?
- bzbarsky 7y ago
  There are two possible options there. 1) The loan is still on your books. In that case, you are in the same situation as an individual who has invested money in a 4% bond and can't withdraw it from there while at the same time paying 6% on a car (or house, or whatever) loan. It's annoying, for sure, but whether it's a serious problem depends on your net assets (which you might draw down to make up the difference) and your net income at that point (which will depend on whether you are still managing to make loans at higher than 6%). Also, 20 * 1.5 - 10 * 2 = 10, so I think you you still come out positive in this scenario, subject to some _really_ simplifying assumptions like the rates being 2.5 and 4 for 2 years and then jumping to 6 and 4, and ignoring the fact that money now is more valuable than money later, etc. But yes, if you keep the loan on your books you do run the risk that rates will go up and the money will not be optimally invested; you presumably try to model that risk and price it into your rates. 2) You sold the loan on to investors in the form of bonds. In that case you really don't care that much, as the loan originator. The investors who bought a 3.25% (or whatever; some loan management fees come off the top) bond now have the problem of having a bond that is paying likely below-inflation rates, and can't be sold, except at a loss, because of that. If the question is why investors would buy such a bond now, it's because they need something to invest in and pickings are pretty slim if they want a risk profile better than stocks (and we can argue whether morgage-backed securities give you that) and they are betting rates won't go up that much. Now you could ask why people generally buy fixed-yield bonds at all, which is really the same question. My guess would be that partly this is a bet that rates won't rise (partly driven by central banks' commitment to macro stability and therefore not having too-large changes in interest rates). And maybe partly an issue of what time horizon the bond purchasers are operating on...
  - lumost 7y ago
    fixed yield bonds/mortgages also provide an interesting hedge in the current climate against 1) Recession 2) Negative interest rates. in theory one could make a bet that a recession will occur in X months forcing a rate cut/stock decline and use leverage on fixed rate investments to make an above average return.

caf 7y ago

They are in the business of borrowing short and lending long, with a rate spread to make money in the process. See that makes sense with variable rates. However if you offer a 30-year fixed rate at 4% because you know that you can currently borrow short at 2.5%, what happens in 20 years time when no-one is willing to lend short to you for less than 6%?

bzbarsky 7y ago
There are two possible options there. 1) The loan is still on your books. In that case, you are in the same situation as an individual who has invested money in a 4% bond and can't withdraw it from there while at the same time paying 6% on a car (or house, or whatever) loan. It's annoying, for sure, but whether it's a serious problem depends on your net assets (which you might draw down to make up the difference) and your net income at that point (which will depend on whether you are still managing to make loans at higher than 6%). Also, 20 * 1.5 - 10 * 2 = 10, so I think you you still come out positive in this scenario, subject to some _really_ simplifying assumptions like the rates being 2.5 and 4 for 2 years and then jumping to 6 and 4, and ignoring the fact that money now is more valuable than money later, etc. But yes, if you keep the loan on your books you do run the risk that rates will go up and the money will not be optimally invested; you presumably try to model that risk and price it into your rates. 2) You sold the loan on to investors in the form of bonds. In that case you really don't care that much, as the loan originator. The investors who bought a 3.25% (or whatever; some loan management fees come off the top) bond now have the problem of having a bond that is paying likely below-inflation rates, and can't be sold, except at a loss, because of that. If the question is why investors would buy such a bond now, it's because they need something to invest in and pickings are pretty slim if they want a risk profile better than stocks (and we can argue whether morgage-backed securities give you that) and they are betting rates won't go up that much. Now you could ask why people generally buy fixed-yield bonds at all, which is really the same question. My guess would be that partly this is a bet that rates won't rise (partly driven by central banks' commitment to macro stability and therefore not having too-large changes in interest rates). And maybe partly an issue of what time horizon the bond purchasers are operating on...
- lumost 7y ago
  fixed yield bonds/mortgages also provide an interesting hedge in the current climate against 1) Recession 2) Negative interest rates. in theory one could make a bet that a recession will occur in X months forcing a rate cut/stock decline and use leverage on fixed rate investments to make an above average return.