Building a rate sheet is a pretty simple mathematical equation. How much does the company get paid for that particular loan and how much does the company have to pay out.
Five main variable components go into rate-sheet pricing and interest rates. The bond price, servicing value, lenders’ cost to manufacture, loan originator compensation, and the borrowers’ risk profile.
For this segment we will focus on the bond price. We don’t have much control over the bond price and that’s why we hedge. Hedging protects against interest rate risk, i.e. the change in bond price from the time a loan is locked to the time a loan is closed and sold on the secondary market. If a loan is locked at a 7.000% interest rate today that pays the lender 300 basis points or 3 percent, and the bond price goes down by 200 basis points by time the loan closes, the lender will only be paid 100 basis points when they sell the loan. Hedging offsets the difference of that market movement.