Where Does the Money Come From for Mortgage Loans?

Where Does the Money Come From for Mortgage Loans?

In the "olden" days, when someone wanted a home loan they walked downtown to the neighborhood bank or savings & loan. If the bank had extra funds laying around and considered you a good credit risk, they would lend you the money from their own funds.

It doesn't generally work like that anymore. Most of the money for home loans comes from three major institutions:

Fannie Mae (FNMA - Federal National Mortgage Association)
Freddie Mac (FHLMC - Federal Home Loan Mortgage Corporation)
Ginnie Mae (GNMA - Government National Mortgage Association)

This is how it works:

You talk to practically any lender and apply for a loan. They do all the processing and verifications and finally, you own the house and now you have a home loan and you make mortgage payments. You might be making payments to the company who originated your loan, or your loan might have been transferred to another institution. The institution where you mail your payments is called the "servicer," but most likely they do not own your loan. They are simply "servicing" your loan for the institution that does own it.

You see, what happens behind the scenes is that your loan got packaged into a "pool" with a lot of other loans and sold off to one of the three institutions listed above. The servicer of your loan gets a monthly fee from the investor for servicing your loan. This fee is usually only 3/8ths of a percent or so, but the amount adds up. There are companies that service over a billion dollars of home loans and it is a tidy income.

At the same time, whichever institution packaged your loan into the pool for Fannie Mae, Freddie Mac, or Ginnie Mae, has received additional funds with which to make more loans to other borrowers. This is the cycle that allows institutions to lend you money.

What Freddie Mac, Ginnie Mae, and Fannie may do after they purchase the pools, is break them down into smaller increments of $1000 or so, called "mortgage backed securities." They sell these mortgage backed securities to individuals or institutions on Wall Street. If you have a 401K or mutual fund, you may even own some. Perhaps you have heard of Ginnie Mae bonds? Those are securities backed by the mortgages on FHA and VA loans.

These bonds are not ownership in your loan specifically, but a piece of ownership in the entire pool of loans, of which your loan is only one among many. By selling the bonds, Ginnie Mae, Freddie Mac, and Fannie Mae obtain new funds to buy new pools so lenders can get more money to lend to new borrowers.

And that is how the cycle works.

So when you make your payment, the servicer gets to keep their tiny part, and the majority is passed on to the investor. Then the investor passes on the majority of it to the individual or institutional investor in the mortgage backed securities.

From time to time your loan may be transferred from the company where you have been making your payment to another company. They aren't selling your loan again, just the right to service your loan.

There are exceptions.

Loans above $227,150 do not conform to Fannie Mae and Freddie Mac guidelines, which is why they are called "non-conforming" loans, or "jumbo" loans. These loans are packaged into different pools and sold to different investors, not Freddie Mac or Fannie Mae. Then they are securitized and for the most part, sold as mortgage backed securities as well.

This buying and selling of mortgages and mortgage backed securities is called "mortgage banking," and it is the backbone of the mortgage business.

Types of Mortgage Lenders

Mortgage Bankers

Mortgage Bankers are lenders that are large enough to originate loans and create pools of loans which they sell directly to Fannie Mae, Freddie Mac, Ginnie Mae, jumbo loan investors, and others. Any company that does this is considered to be a mortgage banker.

Some companies don't sell directly to those major investors, but sell their loans to the mortgage bankers. They often refer to themselves as mortgage bankers as well. Since they are actually engaging in the selling of loans, there is some justification for using this label. The point is that you cannot reliably determine the size or strength of a particular lender based on whether or not they identify themselves as a mortgage banker.

Portfolio lenders

An institution which is lending their own money and originating loans for itself is called a "portfolio lender." This is because they are lending for their own portfolio of loans and not worried about being able to immediately sell them on the secondary market. Because of this, they don't have to obey Fannie/Freddie guidelines and can create their own rules for determining credit worthiness. Usually these institutions are larger banks and savings & loans.

Quite often only a portion of their loan programs are "portfolio" product. If they are offering fixed rate loans or government loans, they are certainly engaging in mortgage banking as well as portfolio lending.

Once a borrower has made the payments on a portfolio loan for over a year without any late payments, the loan is considered to be "seasoned." Once a loan has a track history of timely payments it becomes marketable, even if it does not meet Freddie/Fannie guidelines.

Selling these "seasoned" loans frees up more money for the "portfolio" lender to make more loans. If they are sold, they are packaged into pools and sold on the secondary market. You will probably not even realize your loan is sold because, quite likely, you will still make your loan payments to the same lender, which has now become your "servicer."

Direct Lenders

Lenders are considered to be direct lenders if they fund their own loans. A "direct lender" can range anywhere from the biggest lender to a very tiny one. Banks and savings & loans obviously have deposits they can use to fund loans with, but they usually use "warehouse lines of credit" from which they draw the money to fund the loans. Smaller institutions also have warehouse lines of credit from which they draw money to fund loans.

Direct lenders usually fit into the category of mortgage bankers or portfolio lenders, but not always.

One way you used to be able to distinguish a direct lender was from the fact that the loan documents were drawn up in their name, but this is no longer the case. Even the tiniest mortgage broker can make arrangements to fund loans in their own name nowadays.

Correspondents

Correspondent is usually a term that refers to a company which originates and closes home loans in their own name, then sells them individually to a larger lender, called a sponsor. The sponsor acts as the mortgage banker, re-selling the loan to Ginnie Mae, Fannie Mae, or Freddie Mac as part of a pool. The correspondent may fund the loans themselves or funding may take place from the larger company. Either way, the loan is usually underwritten by the sponsor.

It is almost like being a mortgage broker, except that there is usually a very strong relationship between the correspondent and their sponsor.

Mortgage Brokers

Mortgage Brokers are companies that originate loans with the intention of brokering them to lending institutions. A broker has established relationships with these companies. Underwriting and funding takes place at the larger institutions. Many mortgage brokers are also correspondents.

Mortgage brokers deal with lending institutions that have a wholesale loan department.

Wholesale Lenders

Most mortgage bankers and portfolio lenders also act as wholesale lenders, catering to mortgage brokers for loan origination. Some wholesale lenders do not even have their own retail branches, relying solely on mortgage brokers for their loans. These wholesale divisions offer loans to mortgage brokers at a lower cost than their retail branches offer them to the general public. The mortgage broker then adds on his fee. The result for the borrower is that the loan costs about the same as if he obtained a loan directly from a retail branch of the wholesale lender.

Banks and Savings & Loans - Banks and savings & loans usually operate as portfolio lenders, mortgage bankers, or some combination of both.

Credit Unions - Credit Unions usually seem to operate as correspondents, although a large one could act as a portfolio lender or a mortgage banker.

The Advantages of Different Types of Mortgage Lenders

What kind of lender is "best?"

If you ask a loan officer, "What kind of lender is best?" it is going to be whatever kind of company he works for and he will give you a list of reasons why. If you meet the same loan officer years later, and he works for a different kind of lender, he will give you a list of reasons why that type of lender is better.

Realtors will also have differing opinions, and their opinions have changed over time. In the past, it seemed like most would often recommend portfolio lenders. Now they usually recommend mortgage bankers and mortgage brokers. Most often they direct you to a specific loan officer who has demonstrated a track record of service and reliability.

This article discusses the advantages and disadvantage of different types of institutions, not the individual loan officers. However, it is often more important to choose the correct loan officer, not the institution. The loan officer has many responsibilities, one of which is to act as your representative and advocate to the lender he works for or the institutions he brokers loans to. You want someone who has proven dependable and ethical in the past.

Regarding the institutions, the truth of the matter is that each type of lender has strengths and weaknesses. This does not even take into account the variety of other factors that influence whether a lender is "good" or "bad." Quality can vary, depending on the loan officer, the support staff, which branch or office you are obtaining your loan from, and a variety of other factors.

PORTFOLIO LENDERS

Savings & Loans are quite often portfolio lenders, as are some banks. Portfolio lenders generally promote their own portfolio loans, which are usually adjustable rate loans. They will often pay more compensation to their loan officers for originating a portfolio product than for originating a fixed rate loan. You may also find that they are not as competitive as mortgage bankers and brokers in the fixed rate loan market.

However, it is often easier to qualify for a portfolio loan, so borrowers who may not qualify for a fixed rate loan may be able to obtain a loan from a portfolio lender. A borrower may be able to qualify for a larger loan from a portfolio lender than he could obtain from a fixed rate lender.

Portfolio lenders also can serve as "niche" lenders because certain things are more important to them than meeting the more standardized underwriting guidelines of a mortgage banker. An example would be a savings & loan which is more concerned with an individual's savings history than being able to fully document income, among others things.

If you apply for a loan with a portfolio lender and you are declined, you usually have to start the process over with a new company.

MORTGAGE BANKERS

If we are talking about the larger mortgage bankers, you can count on them having several strengths. For the biggest ones, you will recognize the "brand name."

Usually, they are much better at promoting special first time buyer programs offered by states and local governments, that have lower interest rates and costs than the current market rate. These programs are often available to buyers who have not owned a home in the last three years and fall within certain income guidelines.

Mortgage bankers may have problems just because they are "too big" or they may operate like well oiled machines.
If you are buying a home and you need a VA or FHA loan and the development you are buying in has not yet been approved, they will be better at getting it approved than other lenders.

If your home loan is declined for some reason, many mortgage bankers allow their loan officers to broker the loan to another institution. However, because your loan officer is so used to promoting the company's product, he may not be familiar with which institution may be the best one to submit your loan to. Another reason is because wholesale lenders do not expect to get many loans from direct mortgage bankers, so they do not expend much marketing effort on them.

BANKS and SAVINGS & LOANS

Their major strength is that you will recognize their name. In addition, they will usually be operating as a mortgage banker. a portfolio lender, or both, and have the same weaknesses and strengths.

MORTGAGE BROKERS

The major strength of mortgage brokers is that they can shop the wholesale lenders for which lender has the best rate much easier than a borrower can on his own. They also learn the "hot points" of certain wholesale lenders and can hand-pick the lender for a borrower which may be unique in some way. He will be able to advise you whether your loan should be submitted to a portfolio lender or a mortgage banker. Another advantage is that, if a loan gets declined for some reason, they can simply repackage the loan and submit it to another wholesale lender.

One additional advantage is that mortgage brokers tend to attract a high number of the most qualified loan officers. This is not universal. Mortgage brokers also serve as the training ground for those just entering the business. If you have a new loan officer and there is something unique about you or the property you are buying, there could be a problem on the horizon that an experienced loan officer would have anticipated.

A disadvantage is that mortgage brokers sometimes attract the greediest loan officers, too. They may charge you more on your loan which would then nullify the ability of the mortgage broker being able to "shop" for the lowest rate.

WHOLESALE LENDERS

Borrowers cannot get access to the wholesale divisions of mortgage bankers and portfolio lenders without going through a broker.

When Realtors or Builders Recommend a Lender

If your Realtor or builder make a suggestion for a lender, be sure to talk to that lender. One reason Realtors and builders make suggestions has to do with the fact that they have regular dealings with this lender and have come to expect a certain amount of reliability. Reliability is extremely important to all parties involved in a real estate transaction.

On the other hand, a recent trend in mortgage lending has been for real estate companies and builders to own their own mortgage companies or create "controlled business arrangements" (CBA's) in order to increase their profitability. These mortgage brokers sometimes become used to having what is essentially a "captured market" and may not necessarily offer you the lowest rates or costs.

Some real estate companies also offer different types of incentives to their Realtors to recommend their company-owned mortgage and escrow companies or lenders with whom they have CBA's. Dealing with one of these lenders is not necessarily a bad thing, though. The builder or real estate company often feel they have more ability to expedite matters when they own the company or have a controlled business relationship. They cannot usually influence the underwriting decision, but they can sometimes cut through "red tape" to handle problems or speed up the process. Builders are especially forceful on having you use their lender. One reason is that there are certain intricacies in dealing with new homes. If you use a loan officer who usually deals with refinances or resale home loans, he may not even be aware of how different it is to close a mortgage on a new home and this can lead to problems or delays.

It is in your interest to know if there is any kind of ownership relationship or controlled business arrangement between the real estate or builder and the lender, so be sure to ask. Do not automatically disqualify such a lender, but be sure to be more vigilant on getting the best interest rate and the lowest costs.

CONCLUSION

Make sure to do a little shopping for yourself. By knowing the interest rates of the market and making sure your loan officer knows you are looking at rates from other institutions, you can use that as leverage to make sure you are obtaining the best combination of service and lowest rates.

The Advantages of Different Types of Mortgage Lenders

The No-Cost Thirty Year Fixed Rate Mortgage

There really is no such thing as a "no-cost" mortgage loan. There are always costs, such as appraisal fees, escrow fees, title insurance fees, document fees, processing fees, flood certification fees, recording fees, notary fees, tax service fees, wire fees, and so on, depending on whether the loan is a purchase or a refinance. The term "no-cost" actually means that your lender is paying the costs of the loan. All a "no cost" loan means is that there is no cost to you, the borrower.

Except that you pay a higher interest rate.

Understand How Loans Are Priced

A variation of the no-cost loan is the "no points" loan, or even the "no points, no lender fees" loan. On these loans you pay all the costs associated with buying a house or refinancing, but you do not have to pay the lender associated fees or points. However, since lenders and loan officers do not do anything for free, the profit has to come from somewhere.

So where does it come from?

First, you have to understand how loans are priced and how mortgage lenders and loan officers earn income. Each morning mortgage companies create rate sheets for loan officers. The rates usually change slightly from day to day. In volatile markets they change several times a day. On the rate sheet, there are many different programs, including the thirty year fixed rate.

There will be one column which will lists several different interest rates and another column that lists the "cost" for that particular rate. For example:

Rate Cost(points)

====== =============

6.250% 2.000

6.375% 1.500

6.500% 1.000

6.625% 0.500

6.750% 0.000

6.875% (0.500)

7.000% (1.000)

7.125% (1.500)

7.250% (2.000)

In the above example, 6.75% has a "par" price, which means it has a zero cost. The lower in rate you go, the higher the cost, or "points." A point is equal to one percent of the loan amount. The parentheses in the cost column for the higher interest rates indicates a negative number. For example, (1.500) equals -1.500, which means instead of having a cost associated with the loan, the lender is willing to pay out money for those interest rates. This is called "premium" or "rebate" pricing.

-- Zero Cost Loans --

How Mortgage Companies and Loan Officers Make Money

The above rate sheet is not a rate sheet designed for public review. In fact, most lenders have a policy that the public cannot see their internal rate sheet. This rate sheet is designed for loan officers and the cost column is the loan officer's cost, not the cost to the borrower. When the loan officer quotes you an interest rate, he will add on a certain amount, usually one to one and a half points. Most companies leave it up to the loan officer's discretion how much to add on to the base cost. However, they usually require at least a minimum add-on, which is usually one point.

The loan officer's commission depends on his "split" with the company and can vary. He receives a portion of the add-on and the rest goes to the company.

If we assume the loan officer is adding on one point, and you were willing to pay one point for your loan, then your rate would be (according to this rate sheet) 6.75%. You would pay one percentage point and receive an interest rate of six and three-quarters. If you wanted a lower rate and were willing to pay two points, you could get six and a half percent. If you wanted a "no points" loan, then your rate would be seven percent. The loan officer and the mortgage company would split the one point rebate, listed as (1.000) on the rate sheet.

See how it works?

In addition to the cost noted on the rate sheet above, lenders have certain other fees they like to collect, too. These can include document fees, processing fees, underwriting fees, warehouse fees, flood certification fees, wire transfer fees, tax service fees, and so on. Usually, you will not be charged all of these fees, it is just that different lenders call them different things. Some of them are legitimate costs to the lender and some of them are simply fees designed to generate additional income to the mortgage company. They are customary in today's mortgage market and can vary from around $600 to $1300. In addition, there will usually be an appraisal fee and a credit report fee. Appraisals and credit reports are usually contracted out to independent companies even though these are considered to be lender fees.

Note that it is common for companies who charge higher fees to have a slightly lower interest rate and companies that charge lower fees will usually have a slightly higher interest rate. So if you shop entirely based on fees, you may actually spend more money in the long run because your interest rate may be higher.

The point is that if you want a "no points - no lender fees" loan, then on our rate sheet above, you may get an interest rate of 7.125%. That is because the loan officer has to bump the interest rate even further than on a "no points" loan in order to cover his own company's fees.

If you want a "no cost" loan, then the loan officer has to bump your interest rate even further. That is because all of the costs on your purchase or refinance do not come from the lender. The escrow or settlement company involved in your transaction will charge a fee which must be paid. The lender will require title insurance and the title insurance company charges a fee for providing this insurance. If your new lender requires information from your homeowner's association (if you have one) then the homeowner's association will most likely charge a fee for providing those documents. If you are refinancing, your current lender will usually charge at least two fees: a "demand" fee, and a "reconveyance" fee. The demand fee is charged simply for providing payoff information. The reconveyance fee is charged because your current lender prepares a document which releases your property as collateral for their outstanding loan. This document is called a reconveyance.

These charges will add about another point to how much the loan officer must collect in premium pricing in order to cover the costs associated with your refinance or purchase. For a zero cost loan, he will normally need to collect somewhere in the neighborhood of two and a half points. Because points are a percentage of your loan amount and most of the costs are fixed, it takes fewer points to provide zero costs on higher loan amounts. On smaller loan amounts it takes more. One percent of $200,000 is two thousand dollars and one percent of $100,000 is only $1000, so you can see how it is easier to cover costs on larger loans.

Does it makes sense to do a zero cost loan?

On a $200,000 thirty year fixed rate loan, the difference in monthly mortgage payments will be about $87, using the example rate sheet on the first page. Over thirty years, it works out that you will pay more than $30,000 extra for getting a zero cost loan. So if you intend to remain in the home for a long period of time it just doesn't make sense.

Suppose you intend to stay for only five years? On a purchase, using the $200,000 example, if you stayed longer than fifty-five months, it would make more sense to pay your own costs and get the lower interest rate. If you kept the loan for a shorter time, then it makes more sense to pay zero costs and get a higher interest rate.

Except for one thing.

If you knew you were only going to be staying in the home for five years you would probably not want a thirty year fixed rate, anyway. You would get a loan which has a fixed payment for the first five years, then convert to an adjustable or whatever fixed rates are five years from now. These loans have an interest rate almost a half percent lower than thirty year fixed rate loans. Since it is practically impossible to do a zero cost loan on this type of loan, you would have to compare a zero cost thirty year fixed rate loan to paying points on a loan with a fixed payment for five years.

The difference in payments would be about $150. The two and a half point rebate equals $5000. Working out the math, if you stayed in the home longer than thirty-three months, it would make more sense to pay the points and get the loan with the five year fixed rate.

Finally, carry the discussion one step further. Suppose you know you are going to be in the new loan for less than three years? Doesn't it make sense to get a "zero cost" loan then?

No.

Then you get an adjustable rate loan. As long as the start rate is two percent lower than the current fixed rate, you cannot lose. The first year you will save a lot of money. The second year you will probably break even. The third year, you will probably give up some of the savings from the first year, but not all of them.

"Zero cost" loans just don't make sense for Homebuyers.
But they sound really good in an advertisement.

Exceptions:

On a FHA Streamline Refinance Without an Appraisal (not a purchase - which is what the article talks about), it makes sense to do a zero cost loan. This is mostly because the new loan has to be exactly the same amount as the existing balance of the current loan.
If the Homebuyer only has enough money for down payment and none to cover closing costs, PLUS no arrangement can be made for the seller to pay closing costs, then zero costs may make sense (however, I would still recommend negotiating terms with the homeseller - be willing to pay a higher price in exchange for the seller paying your costs)