The purchase of a home is generally the largest acquisition consumers make in their lifetime. Most consumers do not have the financial wherewithal to purchase a home outright and must obtain a real estate loan to finance the transaction. There are a wide range of loan products available to meet the varied financial needs of consumers.
The real estate lending industry has grown substantially over the past years and is approaching $4 trillion in outstanding loan balances. The total real estate debt in the country is the largest in the world, second only to the United States government. The residential real estate lending industry is comprised of two distinct areas: the primary market and the secondary mortgage market; there are a host of other ancillary entities that service and support the real estate lending process as well. We will discuss each of these areas below.
Primary Mortgage Market
The primary mortgage market covers the entire process a consumer encounters in obtaining a real estate loan. The process includes the consumer's completion of a loan application form, validation of the credit and property information, loan underwriting by the lender and closing of the mortgage loan. Generally, the consumer's primary contact throughout this process is the loan officer. The loan officer acts as the consumer's navigator through the primary market "maze" and provides assistance in:
- Identifying appropriate loan programs, based on the consumer's needs;
- Completion of the loan application form;
- Obtaining documentation necessary to validate credit and property value;
- Compiling supporting information in a package suitable to submit to lenders;
- Communications between the lender and the consumer.
The loan officer may work for a mortgage broker, a mortgage banker or a financial depository institution. Each of these entities is described below. The loan officer is typically paid a percentage of the fees collected by the lender.
Historically, the process of obtaining a loan has taken several weeks to complete. In the future, this time frame is expected to improve dramatically as the application process, credit validation and loan underwriting become more automated. Some industry experts believe that in the near future, the primary market process will be completed in hours and days rather than weeks and months.
The Major Players
The major players in the primary market are mortgage brokers, mortgage bankers and depository financial institutions.
One of the major providers of real estate loans are mortgage brokers. They have access to a wide range of mortgage lending products through relationships with mortgage bankers and depository institutions. Because mortgage brokers are approved through multiple lenders, they have the flexibility to place most loans.
Mortgage brokers employ loan officers, who, as described above, work directly with the consumer in obtaining home financing. They assist the consumer in completing the application and loan selection process and direct them to suitable lenders to fund the mortgage. Occasionally, mortgage brokers have relationships with mortgage bankers which allow them to underwrite and fund the loans.
Mortgage brokers charge a fee to assist the borrower with the loan placement. The fee is paid to the broker when the loan funds. Mortgage brokers are typically regulated by state agencies, such as the Department of Real Estate.
Another major participant in the primary market are mortgage bankers. Mortgage bankers are financial intermediaries that review the creditworthiness of a borrower, provide the funds for the loan and quickly sell those mortgages into the secondary mortgage market. There are two kinds of mortgage banking operations: retail and wholesale. Retail mortgage bankers employ loan officers that perform the same functions as mortgage brokers by assisting borrowers with the application and loan selection process. Wholesale mortgage bankers do not employ loan officers, but obtain their business directly from mortgage brokers. There is no difference in fees charged by mortgage brokers accessing lenders on a wholesale basis and those charged by retail lenders who use their own loan officers.
Mortgage bankers typically do not have the resources to portfolio loans. Therefore, they sell the mortgages they fund to secondary market investors, such as Fannie Mae or Freddie Mac, or transfer the loans to an affiliate company, such as a financial depository institution, to be held in portfolio. Although the loan is sold shortly after funding, mortgage bankers may elect to service the loan on behalf of the secondary market investor acquiring it. Servicing includes collecting the monthly payments from consumers and remitting the funds to the appropriate investors. Mortgage bankers receive a fee for this service directly from the secondary market investors that ranges from .25% to .5% per year.
Sometimes mortgage bankers will sell the loan servicing rights to another mortgage banker or financial institution. When this occurs, borrowers are notified that the loan servicing has been sold and will receive instructions on where to make their monthly payments.
Mortgage bankers are regulated by state agencies, such as the Department of Real Estate or the Department of Corporations. Mortgage bankers that are subsidiaries of financial depository institutions are regulated by their parent company's primary regulatory body.
Financial Depository Institutions:
Historically, the dominant sources of mortgage loans have come from the depository institutions, such as savings and loan associations, savings banks and commercial banks. Savings and loan associations, in particular, have provided a large percentage of mortgage loans to consumers over the years. These depository institutions gather funds from their customers through checking and savings accounts and certificates of deposits (CD's). These funds are then used to make loans, including real estate, auto, business, or personal in nature. In addition to using customers' deposits to make loans, many depository institutions borrow from the Federal Home Loan Bank, the Federal Reserve Bank or other depository institutions and use the proceeds to make loans to their customers. Financial depository institutions are strictly regulated by government agencies, such as the Federal Reserve Board, Office of Thrift Supervision, Office of Comptroller Currency and other state regulatory agencies.
Secondary Mortgage Market
The secondary market revolves around the acquisition and sale of newly closed and seasoned mortgage loans between sophisticated investors and/or mortgage lenders. Before the development of the secondary mortgage market, savings and loan associations and regional banks were the dominant sources of mortgage loans. The development of the secondary mortgage market was the result of government sponsored insuring and guarantee programs, such as the Federal Housing Administration (FHA) and the Veterans Administration (VA), created during the Great Depression. In 1938, the Federal National Mortgage Association (FNMA), a subsidiary of the Reconstruction Finance Corporation, was developed to provide a secondary mortgage market for FHA loans; it subsequently purchased VA loans, as well.
Over the past 20 years, the secondary mortgage market has changed significantly. With the creation of these entities as well as the Federal Home Mortgage Corporation(FHLMC), liquidity for residential mortgage loans has increasingly come from sophisticated investors, such as pension funds, insurance companies, and investors in the national capital markets. The total dollar amount of outstanding residential mortgage loans exceeds any public or private financing type in the domestic United States, except the federal government.
Mortgage loans are sold individually or in pools of loans, such as mortgage backed securities. When loans are sold in the secondary market, monthly payments are made to the original mortgage lender or to a designated mortgage servicer. Sometimes the loan servicing is sold simultaneously with the sale of the mortgage loan or at a later time.
There are many ancillary services that support the mortgage lending process. Some of the more visible are:
Real Estate Broker and Real Estate Sales Associate:
These professionals assist consumers in the buying and selling of real estate. The real estate professional is usually the first contact consumers have when deciding on a real estate loan, who in turn will refer their clients to a mortgage professional.
Title companies perform a title search on the property and issue a title policy for the lender and the purchaser to insure that there is a valid mortgage lien against the property and title is clear.
This entity facilitates the closing of a mortgage loan by acting as an impartial third party. The closing agent can be an escrow company, an attorney or title company agent depending on the region.
This professional evaluates the market value of real estate for the buyer and the lender.
Credit Reporting Agency:
These companies research the credit records of consumers and memorialize the findings in a factual credit report. They have access to databases that store credit information on most consumers in the country. Additionally, they search the public records for derogatory items that may have been filed against a consumer such as judgments, bankruptcies, and liens. Frequently, credit reporting agencies will research other items, such as place of employment, banking relationships and previous residency.
Private Mortgage Insurance Company (PMI):
When the loan exceeds 80% of the value of the property, lenders usually require private mortgage insurance that insures the lender in the event a borrower defaults and the property ends up in foreclosure. There are a small number of companies that provide this insurance. Usually, borrowers pay for this insurance as part of the monthly payment.
Hazard Insurance Company:
Lenders require hazard insurance that covers the outstanding loan on the property. There are many casualty insurance companies that provide hazard insurance In most cases, the lender is the loss payee on the policy and will receive the proceeds on a claim. The proceeds will then be used to pay for the repairs.