1. Financing Residential Real Estate Lesson 4: The Mortgage Industry

2. Introduction In this lesson, we will cover: steps in the residential mortgage process; participants in the process, including loan originators and lenders; government intervention in the mortgage industry during the Great Depression and the S&L crisis; and the mortgage industry and the current economic crisis.

3. Introduction Note that terminology concerning the mortgage industry isn’t always used consistently throughout the industry. Definitions given here won’t necessarily match the ones you encounter in the field. Terms such as loan origination, loan officer, and mortgage broker are used differently in different contexts and by different people.

4. Overview of the Mortgage Process 1.Home buyer applies for a loan. 2.Loan originator helps buyer with application and submits it to lender(s). 3.Lender approves and funds loan. After the loan has been made: 4.Lender may keep loan in portfolio or sell it on secondary market. 5.Servicer (lender or another entity) collects payments, handles other administrative tasks.

5. Loan Origination Loan originator who helps buyer apply may be: a loan officer, employed by a particular lender, or a mortgage broker, an independent agent who usually works with more than one lender.

6. Loan Origination Loan originator who helps buyer apply may be: a loan officer, employed by a particular lender, or a mortgage broker, an independent agent who usually works with more than one lender. Loan may be originated in: a retail transaction (direct lending), or a wholesale transaction (indirect).

7. Loan Origination Retail lending is the traditional way: 1.Buyer applies to Acme Bank. 2.Loan originator who works with buyer is a loan officer employed by Acme. 3.Loan officer submits application to Acme’s underwriting department. 4.If approved, Acme funds loan. Retail transactions

8. Loan Origination Wholesale lending came to the fore in the 1990s. 1.Buyer applies to Zenith Mortgage. 2.Zenith, acting as an intermediary, may be:  a loan correspondent processing the loan on behalf of a large national lender, MegaBank, or  a mortgage broker submitting the application to one or more lenders, including MegaBank. Wholesale transactions

9. Loan Origination Wholesale transactions By lending indirectly, through local loan correspondents or mortgage brokers, wholesale lenders reduce their overhead. They don’t have to pay for office space or have employees in every place they make loans.

10. Loan Origination Loan correspondents Loan correspondents make loans for large investors, such as life insurance companies, pension funds, or wholesale lenders. Correspondent may handle entire origination process and underwriting, but loan funds ultimately come from the investor or wholesale lender. Local lending institutions and mortgage companies often act as loan correspondents.

11. Loan Origination Mortgage brokers Mortgage broker is only a go-between, not a lender. Brings borrowers and lenders together in exchange for a commission. Helps home buyer choose lender(s) and submit application(s). May provide preliminary approval based on lender’s underwriting rules. But doesn’t actually underwrite, approve, or fund loan, as a general rule.

12. Loan Origination Mortgage brokers Table-funded loan creates the impression that the mortgage broker is the lender. Mortgage broker designated as originating lender in loan documents. Loan actually funded by wholesale lender “at the closing table.” At closing, broker assigns loan rights to true lender, receives service release premium. Raises consumer protection issues.

13. Loan Origination Housing and Economic Recovery Act, 2008 law addressing mortgage crisis, includes Secure and Fair Enforcement for Mortgage Licensing Act. S.A.F.E. is designed to prevent abusive, predatory practices during loan origination. Regulation of loan originators

14. Regulation of Loan Originators S.A.F.E. requires all loan originators to be either federally registered or state-licensed. Registered loan originator: Employed by depository institution or subsidiary. State-licensed loan originator: All others must have state license. Registration or licensing required even for those who perform clerical or support duties. S.A.F.E. licensing and registration rules

15. Regulation of Loan Originators Real estate agents:  generally exempt from S.A.F.E. licensing rules;  but must have originator’s license if compensated by a lender or mortgage broker for helping to arrange a loan. S.A.F.E. licensing and registration rules

16. Regulation of Loan Originators Uniform license applications and reporting requirements for states. Improved information tracking across state lines (background checks, fingerprinting, etc.). Enhanced consumer protection and anti-fraud measures. Fiduciary duties for loan originators. Other S.A.F.E. provisions

17. Regulation of Loan Originators Originator’s fiduciary duties to buyer Traditionally, mortgage broker:  wasn’t buyer’s agent;  didn’t have duty to help buyer choose best financing option or to act in buyer’s best interests.

18. Regulation of Loan Originators Originator’s fiduciary duties to buyer Traditionally, mortgage broker:  wasn’t buyer’s agent;  didn’t have duty to help buyer choose best financing option or to act in buyer’s best interests. But some states have laws giving mortgage brokers fiduciary duties to buyers. And now S.A.F.E. imposes fiduciary duties as a matter of federal law.

19. Summary Loan Origination Loan originator Loan officer Mortgage broker Retail lending Wholesale lending Loan correspondent Table-funded loan S.A.F.E.

20. Mortgage Lenders After helping home buyer prepare loan application, loan originator submits it to a mortgage lender. Lender reviews application and decides whether to approve or reject it. If application approved, lender will fund the buyer’s loan.

21. Types of Mortgage Lenders Main sources of residential mortgage financing in the primary market:  Depository institutions  Commercial banks  Thrift institutions (savings banks and savings and loan associations)  Credit unions  Mortgage companies

22. Types of Mortgage Lenders First U.S. mortgage companies were established in the 1930s.  Not depository institutions  Business focused exclusively on mortgage lending and related services  Also called mortgage banking companies or mortgage bankers Mortgage companies

23. Mortgage Companies Original mortgage companies were private businesses unconnected with banks or other depository institutions. Now some are associated with depository institutions as direct subsidiaries or affiliates. Companies not associated with a depository institution are called independent mortgage companies. Independent vs. associated

24. Mortgage Companies Independent mortgage companies are regulated much less than depository institutions. Not subject to same rules as depository institutions. Not subject to periodic examinations to determine compliance with financial requirements and consumer protection laws. Generally investigated only if complaint filed with FTC or state agency. Independent vs. associated

25. Mortgage Companies Some mortgage companies engage in mortgage brokerage activities as well as mortgage banking activities. Business activities

26. Mortgage Companies Some mortgage companies engage in mortgage brokerage activities as well as mortgage banking activities. Zenith Mortgage could be a:  mortgage banker (a lender),  mortgage broker (a go-between), or  combination of the two. Business activities

27. Mortgage Companies Some mortgage companies engage in mortgage brokerage activities as well as mortgage banking activities. Zenith Mortgage could be:  a mortgage banker (a lender),  a mortgage broker (a go-between), or  a combination of the two. Some companies also service loans. Business activities

28. Mortgage Companies Mortgage companies aren’t depository institutions, so they can’t use depositors’ savings to fund loans. Sources of funds for lending

29. Mortgage Companies Mortgage companies aren’t depository institutions, so they can’t use depositors’ savings to fund loans. Instead, a mortgage company may: act as a loan correspondent for large investors or wholesale lenders, or Sources of funds for lending

30. Mortgage Companies Mortgage companies aren’t depository institutions, so they can’t use depositors’ savings to fund loans. Instead, a mortgage company may: act as a loan correspondent for large investors or wholesale lenders, or draw on a line of credit from a commercial bank, then sell the loans and use the sale proceeds to pay off bank and make more loans. Sources of funds for lending

31. Mortgage Companies Mortgage companies keep few if any loans in portfolio. Loans are either made on behalf of a large investor or sold on the secondary market. Sources of funds for lending

32. Types of Mortgage Lenders Sometimes a private individual makes mortgage loans to home buyers on a small scale. A private lending business: may be legal, or may violate state licensing laws, usury laws, disclosure laws, or predatory lending laws. Alternative sources of financing

33. Types of Mortgage Lenders Most important alternative source of financing for home buyers is the home seller. Seller may provide some or all of the financing. Common when institutional loans are hard to get or interest rates are high. Alternative sources of financing

34. Summary Mortgage Companies & Alternatives  Mortgage company  Mortgage banker  Independent mortgage company  Private lenders  Home sellers

35. Government Intervention Crisis in mortgage industry led to larger credit crunch and crisis in financial markets, spreading to entire U.S. economy and to global economy. Many factors and events came together to create the crisis in the mortgage industry. Mortgage and financial crisis

36. Mortgage and Financial Crisis Housing bubble: Artificial inflation of home prices. In U.S., housing bubble began developing in early 2000s. Housing bubble

37. Mortgage and Financial Crisis Factors contributing to creation of bubble included: Policies promoting homeownership for all; home as investment Growth of subprime market, with increase in predatory lending Relaxation of underwriting standards Nontraditional loans like option ARMs Looser rules, lax oversight for lenders, financial institutions, financial markets Housing bubble

38. Mortgage and Financial Crisis When bubble burst, home values dropped. Owners found themselves “underwater,” owing more than value of home. With no equity, couldn’t refinance to prevent payment shock when ARM or interest-only loan payment increased sharply. Foreclosure rate began to climb. Foreclosure crisis

39. Mortgage and Financial Crisis Mounting foreclosures led to: “Toxic” mortgage-backed securities Bankrupt mortgage lenders Failure of investment banks Foreclosure crisis

40. Mortgage and Financial Crisis Housing and Economic Recovery Act (HERA)  Home buyer tax credit  Programs to purchase foreclosed homes and revitalize neighborhoods  Increased conventional and FHA loan limits  Hope for Homeowners refinancing program  New regulatory agency to oversee Fannie Mae and Freddie Mac Government response

41. Mortgage and Financial Crisis Takeover of Fannie Mae and Freddie Mac Troubled Asset Relief Program (TARP): $700 billion emergency bailout for financial institutions and other companies Government response

42. Summary Mortgage and Financial Crisis  Housing bubble  Subprime loans  Predatory lending  Nontraditional mortgages  Underwater homeowner  Toxic securities  HERA  Hope for Homeowners program  TARP