Why aren't mortgage rates even lower?

Hundred dollar bill folded in shape of a house

Mortgage rates are at historic lows, and many people are flocking to refinance.

Thirty-year mortgages are running around 3.5% for borrowers with good credit.

But rates could be even lower — 2.85% for a 30-year loan, for instance.

To understand why rates aren't that low, it helps to understand a little about how the banking industry treats mortgages.

Banks write mortgages, then sell them to bond market investors. The difference between what the borrower pays and what the banks pay the bondholders is known as the spread.

The spread is a primary profit source for banks.

In September 2011, the spread was 0.74 percentage points, which is pretty close to the 0.77 percentage point average the market has held since the end of 2007. Banks were taking the same profit cut they'd taken for the past four years.

Since then, the spread has gone to more than 1.4 percentage points because bond yields have fallen a lot more than mortgage rates.

Banks are paying investors less, and they aren't passing along those savings to borrowers.

There are a variety of theories for why this is.

One says that banks can't handle the flood of applicants they'd get if a 30-year loan were available at 2.85% and this is their artificial way of controlling demand.

Another says that higher standards from Fannie Mae and Freddie Mac, the two government-owned organizations that guarantee most home loans in this country, are behind the wider spread. Fannie and Freddie have higher lending standards, this theory says, and meeting them is slower and more expensive.

I don't buy the backlog theory.

Banks have gone through two big waves of refinancing since 2008, handling both without a problem — or a widening spread. Large banks say their mortgage departments are up to the challenge.

Evidence suggests they're right. Wells Fargo reported $4.8 billion in revenue from its origination business in the first six months of 2012. That's a 155% increase from the same period in 2011. JPMorgan Chase and U.S. Bancorp, the other big lenders, also reported very high loan origination revenue.

If they do need more processors, there are plenty of people looking for jobs.

I'm not greatly impressed by the "Fannie and Freddie are picky" theory, either. Fannie and Freddie want banks to do a good job on origination, exactly what banks promised they'd do when they got bailout money.

Remember the bailout?

I think banks are charging more because they can. (For what it's worth, former Fannie Mae chief economist Thomas Lawler agrees with me.) Because 3.55% looks great — it is great — there's no consumer pressure to offer anything better.

If I were writing about my local yarn store, I wouldn't think this is so terrible. After all, who sells something for $3 when it flies out the door at $4?

Banks, however, should have a different standard.

These are the institutions that largely caused the 2008 economic meltdown.

This is also the same group that, as part of the settlement made with 49 states that might otherwise be prosecuting its members for unsavory lending practices, has promised to lower both principal and interest for selected borrowers.

Last but certainly not least, banks are behind the foreclosures that have hurt so many communities.

They're not in the property management business, and they typically lose money every time a loan goes south.

A lower rate would reduce payments, which would help keep more people in their homes. That would in turn help communities. A lower rate would also show some goodwill and, dare I say it, a bit of gratitude.

Given the pain that banks' lending practices have caused in the past five years, accepting the same profit margins on mortgages that they enjoyed in 2007 wouldn't seem to be such a great sacrifice.