After posting yesterday’s pre-approval story, one reader asked:

Will you undertake to provide your readers with more information regarding the process of hedging?

We surely will. Here’s the gist of it…

Lenders hedge pre-approvals in a variety of ways.  Among them, they may do so by buying listed or over-the-counter bond options (puts), or by short-selling bonds.

The cost of doing this can be massive.  One industry exec we spoke with said it costs his lender $900 to $1,200 to hedge a 120-day rate hold on a $100,000 mortgage.  It’s basically a linear relationship so the costs on a $300,000 mortgage are three times higher.

With pre-approval funding ratios as low as 15%, at some lenders, you can see why these costs are a concern for the industry.  That doesn’t include the human resource and other expenses that apply to underwriting and supporting pre-approvals.

By the way, for whatever reason, bank-branch funding ratios are higher than broker-funding ratios.  If that doesn’t correct itself, it is very possible that the best pre-approval choices will someday be limited to the big banks.  That would really be unfortunate because it would mean far less choice for consumers.