financing residential real estate lesson 3: residential mortgage lenders

Financing Residential Real Estate

Lesson 3:

Residential Mortgage Lenders

Introduction

In this lesson, we will cover:

different types of mortgage lenders

the Depression

the savings and loan crisis

recent trends in the mortgage industry

Types of Mortgage Lenders

Five main sources of residential mortgage financing in the primary market:

Commercial banks

Savings banks

Savings and loan associations

Credit unions

Mortgage companies


Commercial banks were originally developed to serve commercial entities (merchants and businesses).

Originally, residential mortgages not significant part of their lending business.

Commercial banks

Commercial Banks

Regulatory changes and expansion of secondary market increased commercial bank mortgage lending.

Commercial Banks

Regulatory changes and expansion of secondary market increased commercial bank mortgage lending.

Recently, commercial banks made 20% of country’s mortgage loans.

Commercial lending is still primary focus of commercial banks.

Commercial Banks

Commercial banks are either:

Commercial Banks


national banks chartered by the federal government, or

Commercial Banks


national banks chartered by the federal government, or

state banks chartered by the state government.

Commercial Banks

Investment banks = securities firms that:

raise capital for corporations,

arrange issuance of government and corporate bonds,

manage corporate finances, and

handle mergers and acquisitions.

Distinguished from investment banks

Commercial Banks

Glass-Steagall Act was adopted in 1933 and required banks to choose between commercial and investment banking services.

prohibited banks from providing both

illegal for banks to be involved in insurance business

intended to protect public from conflicts of interest

Distinguished from investment banks

Glass-Steagall Act gradually undermined and eventually repealed in 1999 by the Financial Services Modernization Act.

It’s now legal for holding company to have a bank, securities firm, and insurance company as subsidiaries.


Savings banks began by offering financial services to small depositors, especially immigrants and working class.

They also provide:

home mortgage loans,

Savings banks



They also provide:


consumer loans,

Savings banks



They also provide:


consumer loans, and

financing for purchase of furniture, appliances, and cars.

Savings banks

Savings Banks

Also called mutual savings banks because originally organized as mutual companies.

Before 1982, only 16 states had chartering procedures for mutual savings banks.

Savings Banks

Garn-St. Germain Act passed in 1982, giving savings banks option of a federal charter.

Savings Banks


Can be organized as:

mutual companies,

Savings Banks


Can be organized as:

mutual companies, or

stock companies.


Savings and loan associations (S&Ls) developed in nineteenth century.

Formed in local communities to finance home construction.





Members pooled their assets and took turns using money to build houses.





Members pooled their assets and took turns using money to build houses.

After financing needs satisfied, association dissolved.


Savings and Loan Associations

S&Ls became permanent institutions, providing savings accounts to non-member depositors.

Deregulation during 1970s and 1980s allowed S&Ls to offer checking accounts and other types of lending.

Savings and Loan Associations

S&Ls and savings banks are also called thrifts or “the thrift industry” because of traditional emphasis on savings accounts for small depositors.


A credit union is a nonprofit depository institution that serves the members of a particular group.

Credit unions



Originally didn’t make mortgage loans.

Credit unions



Originally didn’t make mortgage loans.

Specialized in small, unsecured personal loans.

Credit unions

Credit Unions

Credit unions emphasized home equity loans, which are mortgages on a borrower’s equity in a home he already owns.

Generally, these are short-term loans.

Credit Unions

Deregulation in 1980s allowed credit unions to offer long-term mortgages.

Credit unions are:

exempt from taxation

Credit Unions


Credit unions are:


able to offer lower interest rates on loans

Credit Unions


Credit unions are:


able to offer lower interest rates on loans

higher rates on deposits

Summary

Types of Lenders

Commercial banks Investment banks Savings banks Savings and loan associations Thrifts Credit unions


Mortgage companies, which focus on mortgage loans, were first established in the 1930s.

Mortgage companies



not depository institutions

Mortgage companies



not depository institutions

also called mortgage banking companies or mortgage bankers

Mortgage companies

Mortgage Companies

Mortgage companies can’t use depositors’ savings to fund loans because they’re not depository institutions.

How mortgage banking works

Mortgage Companies

Mortgage companies can’t use depositors’ savings to fund loans because they’re not depository institutions.

To raise capital, mortgage companies may do one of two things:


1. Mortgage company borrows money from a commercial bank.


Uses funds to originate mortgages.



Sells mortgages to secondary market investors.



Sells mortgages to secondary market investors.

Company uses proceeds to originate more mortgages and pay bank loan.

2. Mortgage company acts as a loan correspondent.


Makes loans to home buyers on investor’s behalf.



Services the loans for the investor (collects and processes payments).




Investor pays servicing fees.




Investor pays servicing fees.

Correspondents usually work with large investors operating on national scale.

Mortgage Companies

Mortgage companies keep few loans in portfolio.

Loans are either made on behalf of a large investor or sold on the secondary market.


Mortgage Companies

Independent mortgage companies are mortgage companies not affiliated with a bank or thrift.

Independent mortgage companies

Mortgage Companies

Independent mortgage companies are mortgage companies not affiliated with a bank or thrift.

Not subject to same regulation and supervision as banks and thrifts.

Independent mortgage companies


Mortgage banker

Originates loans, which includes processing borrower’s application, underwriting decision, and funding the loan.

Mortgage banker vs. mortgage broker


Mortgage banker

Originates loans, which includes processing borrower’s application, underwriting decision, and funding the loan.

Mortgage broker

Not a lender, but an intermediary who brings a borrower together with a lender in exchange for a commission.



Some mortgage companies do both mortgage banking and mortgage brokering.



Some mortgage companies do both mortgage banking and mortgage brokering.

Real estate agents in some states act as mortgage brokers.



Most important type of private lender for home buyers is the home seller.

Private lenders


Most important type of private lender for home buyers is the home seller.

Sellers often provide some or all of the financing.

Common when institutional loans are hard to get or interest rates are high.

Private lenders


Lending institutions have become “financial supermarkets” offering a wide range of services and loans.

Comparing lenders


Lending institutions have become “financial supermarkets” offering a wide range of services and loans.

Look at lender’s size, style, competence, and integrity.

Comparing lenders

Summary

Mortgage Companies & Private Lenders

Mortgage companies Mortgage banker Loan correspondent Independent mortgage companies Private lenders

Government Intervention

Two other federal interventions in mortgage industry (aside from creation of secondary market agencies).

Occurred during:

1) the Depression, and

2) the savings and loan crisis of the 1980s.

The Depression

As U.S. expanded westward, tremendous growth occurred.

Home purchase loans were considered good investments.

Loans were to be repaid in 5 years.

Value of collateral much higher than loan amounts.

The Depression

After the stock market crash, unemployment rose dramatically.

Hundreds of thousands of home owners defaulted on their mortgages.

Many financial institutions failed.

Mortgage lending and home construction virtually ceased.

Foreclosure epidemic

The Depression

Several agencies and programs were instituted, including:

Federal Housing Administration (FHA);

Federal Home Loan Bank Board (FHLBB); and

Federal National Mortgage Association (Fannie Mae).

New Deal initiatives

The Depression

Depression foreclosures led to the introduction of long-term, fixed-rate, amortized mortgage loans.

Transforming home mortgages

The Depression

Depression foreclosures led to the introduction of long-term, fixed-rate, amortized mortgage loans.

FHA-insured loans had 20- or 30-year terms.

Easier for home buyers to avoid default and foreclosure.


The Depression

By 1940s, long-term loans became standard of the industry.

Today, home buyers choose adjustable-rate mortgages over fixed-rate.


The Savings and Loan Crisis

From 1950s to 1980s, savings and loans were the largest source of mortgage financing.



Due to S&Ls’ ability to make long term loans.



Due to S&Ls’ ability to make long term loans.

Government limited amount of long-term lending by commercial banks.


In those days, primary distinction between S&Ls and commercial banks:

S&Ls held only savings and time deposits.

Commercial banks primarily held demand deposits.


Demand deposits

Kept in checking accounts for use in transactions such as bill paying.

Demand deposits vs. time deposits


Demand deposits


Can be withdrawn on demand.



Demand deposits


Can be withdrawn on demand.

Time deposits

Can be withdrawn without penalty only after giving notice to the financial institution.



Savings deposits

May be withdrawn without notice, but are generally intended to remain on deposit for a long time.

Savings deposits


In 1970s and early 1980s, market interest rates soared and were extremely volatile.

Deregulation



Regulations limited how much interest S&Ls could pay depositors, making it difficult to offer attractive returns.

Deregulation



Regulations limited how much interest S&Ls could pay depositors, making it difficult to offer attractive returns.

S&Ls lost a lot of deposits to more competitive investments.

Deregulation


Congress addressed S&L problems with:

Depository Institutions Deregulation and Monetary Control Act of 1980, and

Garn-St. Germain Depository Institutions Act of 1982.

Deregulation


These laws:

Allowed S&Ls to pay higher interest rates.

Deregulation


These laws:


Preempted state usury laws to allow S&Ls to charge higher interest rates on loans.

Deregulation


These laws:


Preempted state usury laws to allow S&Ls to charge higher interest rates on loans.

Able to make more consumer loans and nonresidential loans.

Deregulation


S&Ls tried new, riskier investments, but these failed in economic slumps.

Deregulation



Hundreds of federally insured S&Ls became insolvent.

Deregulation



Hundreds of federally insured S&Ls became insolvent.

Led to a $124 billion industry bail-out by the federal government.

Deregulation


Congress passed the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in 1989.

Reform



FIRREA did several things, including:

Imposed new rules on S&L lending, to prevent high-risk transactions.

Reform



FIRREA did several things, including:

Imposed new rules on S&L lending, to prevent high-risk transactions.

Reorganized federal agencies that supervise/insure financial institutions.

Reform

Replaced Federal Home Loan Bank Board with the Federal Housing Finance Board and Office of Thrift Supervision.

Reorganized Federal Deposit Insurance Corporation (FDIC) to cover S&L deposits.

Formed the Resolution Trust Corporation to manage insolvent S&Ls.


In last 20 years, mortgage companies have come to dominate mortgage market.

Changing market shares


In last 20 years, mortgage companies have come to dominate mortgage market.

Factors of the shift in the market were:

S&L crisis

Decline in number of S&Ls

Growth of secondary market

Changing market shares

Summary

Government Intervention

The Depression Loan terms Savings and loan crisis Demand deposits Time deposits Savings deposits FIRREA

Mortgage Industry Trends

Processing time of loan applications reduced by:

loan origination software,

automatic underwriting systems, and

credit scoring.

Technological changes


Processing time of loan applications reduced by:

loan origination software,

automatic underwriting systems, and

credit scoring.

Internet lending is gradually gaining popularity with home buyers as well.

Technological changes


In 1980s and 1990s, transformation of primary market from local to national focus accelerated.

Nationwide lending


In 1980s and 1990s, transformation of primary market from local to national focus accelerated.

Result: consolidation of mortgage industry.

Large, nationwide lenders now dominate the market.

Nationwide lending


Effects of consolidation is up for debate.

Some argue that reduced competition among lenders means fewer options for home buyers.

Nationwide lending


Effects of consolidation is up for debate.

Some argue reduced competition among lenders means fewer options for home buyers.

Others argue that large lenders can take advantage of economies of scale.

Higher volume of business = greater efficiency and lower per-unit costs.

Nationwide lending


Distinction between retail lending and wholesale lending is important.

Retail lending = lender works directly with home buyers.

Wholesale lending


Distinction between retail lending and wholesale lending is important.

Retail lending = lender works directly with home buyers.

Wholesale lending = lender works behind the scenes.

Wholesale lending


In retail transactions, the lender handles the entire origination process.

Wholesale lending


In retail transactions, the lender handles the entire origination process.

In wholesale transactions, the lender makes a loan either through a loan correspondent or through a mortgage broker.

Wholesale lending

Wholesale Lending

Loan correspondent

A mortgage company, bank, or thrift that makes and services mortgage loans on behalf of a large investor (typically a wholesale lender).

Wholesale originations

Wholesale Lending

Loan correspondent

A mortgage company, bank, or thrift that makes and services mortgage loans on behalf of a large investor (typically a wholesale lender).

Also called a third party originator.


Wholesale Lending

Loan correspondent processes application and underwrites and funds loan.

Uses underwriting standards of wholesale lender, who has arranged to buy loan on specified terms.


Wholesale Lending

Mortgage broker finds and helps the customer through the loan application process.

Broker submits completed loan application to wholesale lender, who underwrites and funds loan.


Wholesale Lending

In the 1980s, large majority of mortgage originations was from retail lending.

Today, wholesale originations are now 60% of mortgage originations.

Growth of wholesale lending

Wholesale Lending

“Warehouse lenders” are distinct from wholesale lenders.

Warehouse lender = provides retail lender or correspondent with a line of credit to borrow money on short-term basis.

Warehouse lenders


Subprime lending involves making riskier loans.

A credit = Prime or standard financing

A- to B, C, D credit = Subprime financing

Subprime lending


Subprime lending may involve:

poor credit rating,

lack of documentation,

high debt ratio,

nonstandard property, or

large loan amount.

Subprime lending


Subprime lenders charge higher interest rates and higher loan fees in exchange for more flexible underwriting standards.

Subprime rates and fees


More likely to have features such as:

prepayment penalties,

balloon payments, and

negative amortization.



More likely to have features such as:

prepayment penalties,

balloon payments, and

negative amortization.

Subprime lenders often engage in predatory lending practices.



Secondary market for subprime loans grew in 1990s.

Subprime and secondary market



HUD encouraged Fannie Mae and Freddie Mac to enter subprime market to meet affordable housing goals.




HUD encouraged Fannie Mae and Freddie Mac to enter subprime market to meet affordable housing goals.

GSEs only purchasing very top layer of market.



Subprime market boom ended in the late 1990s.

Default rate went up.

Subprime lenders went out of business.



Subprime market boom ended in the late 1990s.

Default rate went up.

Subprime lenders went out of business.

Market continues to grow at steady rate today, but prime loans remain the standard.


Summary


Nationwide lending Retail lending Wholesale lending Third party originator Broker originations Warehouse lenders Subprime lending

financing residential real estate lesson 3: residential mortgage lenders

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