REAL ESTATE
FINANCE
10th Edition
J. Keith Baker and John P. Wiedemer
Chapter 4
Other Primary Market Lenders
2
LEARNING OBJECTIVES
At the conclusion of this chapter, students will be able to:
•
Understand the unique relationship of the mortgage companies and
mortgage brokers to the real estate finance industry.
•
Describe the purposes of a mortgage bank and how they differ from
those of a mortgage broker.
•
Understand the licensing and registration requirements for those
engaged in making residential mortgage loans.
•
Explain the basics of the various methods of funding mortgage-lending
activities.
•
Describe the principal source of income for mortgage lenders.
•
Describe the other primary sources of real estate mortgage financing.
•
Discuss the role of the various government loan programs for the
direct financing of real estate.
3
Introduction
• This chapter examines mortgage companies, which include
both mortgage bankers and mortgage brokers.
• Mortgage companies were a dominant source of residential
mortgages from the 1980s to 2007, when they handled close to
half of all loans.
• One effect of the recent financial crisis has been the consolidation
of the mortgage banking industry and the increasingly important
role of commercial banks as residential mortgage originators.
• At the end of 2013, commercial banks originated 54% of residential
mortgage loans.
• Agricultural real estate finance encompasses a smaller segment
of the loan market and has seen extensive changes.
• Another portion of the loan origination market involves individuals
and others who participate in making mortgage loans.
4
Mortgage Companies
• Mortgage companies without depositors were not a
concern for the government.
• Mortgage companies were granted no help in recovery
after the Depression.
• Mortgage companies then promoted FHA and VA loans,
which had been widely rejected by regulated lenders.
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Mortgage Companies
(continued)
• Mortgage companies are still the main originators of
FHA and VA loans.
• Mortgage companies share the mortgage market
with regulated lenders; each has a market share of
about half of all loan originations.
• Mortgage companies rely on commercial banks that
grant them “warehouse” lines of credit.
• Mortgage bankers lend money and mortgage
brokers broker loans.
6
Mortgage Brokers
• With the decline in the savings and loan industry, residential
mortgage brokers came to the forefront.
• Knowledgeable individuals formerly trained in regulated
institutions began working as mortgage brokers.
• Residential mortgage loan brokers are now referred to by their
primary licensing regulator, the National Mortgage Licensing
System (NMLS), as “mortgage loan originators” (MLOs).
• The NMLS was created to provide a uniform mortgage
application; a nationwide repository of licensed mortgage
professionals; and a minimum education, experience, and
testing requirement Under the Secure and Fair Enforcement for
Mortgage Licensing Act (SAFE).
• The SAFE Act requires all residential mortgage loan officers
who work at federally regulated institutions to have a unique
identifier or registration number generated by the NMLS.
7
Mortgage Brokers
• A mortgage broker specializes in serving as an
intermediary between the customer/borrower and the
client/lender.
• Brokers are capable of handling all arrangements for the
processing of the loan, but they normally do no funding
and do not service the loan.
• The broker earns a portion of the normal origination fee
plus an application fee.
• Large commercial loans are normally funded directly by
the lending institution, such as an insurance company,
and the monthly payments on debt service go directly
to the lender.
8
Mortgage Bankers
• The distinction between “bankers” and “brokers” has
diminished.
• Nevertheless, an essential difference between the two
remains—the full-service facility offered by mortgage
bankers.
• Full service means:
(1) originating the mortgage loan
(2) funding the loan at closing
(3) servicing the loan as it is paid off
• But even this distinction is blurring as brokers divide
themselves into those who close loans in their own
names and those who close in another lender’s name.
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Qualifications of a Mortgage Lender
• With the passage of the SAFE Act in 2008, the federal
government signaled its intent to increase uniformity in the
regulation and licensing of residential mortgage loan
originators.
• The SAFE Act eases regulatory burdens, enhances consumer
protection, and reduces fraud by establishing the NMLS.
• This new regulation has had the greatest effect on the
independent residential mortgage brokerage community.
• Mortgage company qualifications are set mostly within the
industry itself, although many states require mortgage
company licensing.
• Approvals by either HUD/FHA or VA in the past were often
accepted by conventional lenders as adequate qualification
except for minimum capital requirements, which can be much
higher for Fannie Mae and Freddie Mac.
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Licensing of Mortgage Loan Officers
• By 1996 all but eight states had some registration or
licensing requirements for the mortgage industry.
• State and federal officials determined that a uniform
licensing method should be implemented, and
Congress passed the SAFE Act.
• The SAFE Act mandates minimum standards for
mortgage loan originators, including the following five
general requirements:
1. A criminal history and credit background check
2. Pre-licensure education
3. Pre-licensure testing
4. Continuing education
5. Evidence of certain net worth and provide a bond
or recovery fund
11
http://mortgage.nationwidelicensingsystem.org/slr/
Pages/default.aspx
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Licensing of Mortgage Loan Officers
• The requirements above apply to those residential loan
originators who do not work for an institution that
takes federally insured deposits.
• The NMLS grants national licenses and unique
identifier numbers to individuals whom it refers to as
mortgage loan originators or MLOs.
• Texas uses the term “Residential Mortgage Loan
Originator” to describe its licensees.
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Who Needs to Register With NMLS?
If your institution is federally chartered or insured by
one of the following agencies and employs individuals
required to be federally registered as mortgage loan
originators, your institution must register with NMLS.
• Office of the Comptroller of the Currency
• Board of Governors of the Federal Reserve System
• Federal Deposit Insurance Corporation
• Office of Thrift Supervision
• Farm Credit Administration
• National Credit Union Administration
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Mortgage Company Operations
• The business organization common to most operates
with three basic divisions: (1) administration, (2) loan
servicing, and (3) loan acquisition.
• The administrative group directs all operations and seeks
out lending institutions and poolers of mortgages for
mortgage-backed securities.
• Loan servicing includes the record-keeping section that
maintains borrowers’ accounts, holds insurance and tax
deposits, collection of monthly payments, and
notifications of delinquencies.
• The loan acquisition group consists of loan originators/
officers who make the contacts with potential borrowers.
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How a Mortgage Company Funds Loans
• Mortgage companies do not hold deposit assets that
can be loaned.
• They must use different procedures to obtain funds for loans.
• Mortgage bankers generally borrow money from a
commercial banker on a warehouse line of credit to fund a
loan at closing.
• The loan is pledged as collateral and held, or “warehoused,”
by the bank until it can be sold.
• Other methods are used by mortgage companies dealing
with the larger commercial loans.
• These loans are more likely to be placed on a case by case
basis with the most suitable lender available at the time.
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Sale of Loans to Secondary-Market Investors
• A procedure long used by mortgage companies is the purchase
of a forward commitment in advance of making any loans.
• This commitment is a promise by a lender to have certain
funds available for qualifying loans submitted to that lender.
• With a forward commitment, the mortgage company assures
a banker that loans pledged on a warehouse line of credit
have a ready market.
• A forward commitment often includes an agreement for the
mortgage company to service the loans that are delivered to
the loan purchaser.
• The agreement between originator and purchaser is known
as a sales and servicing contract.
• Fannie and Freddie buy loans through the sale of forward
commitments
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Representative or Correspondent Basis
• Insurance companies, pension funds, and other loan purchasers
sometimes specialize in handling certain kinds of property
loans, such as those for hotels or shopping centers.
• Rather than deal with a variety of loan originators, these
companies often work through selected representatives
throughout the country.
• These representatives (correspondents) are commercial loan
companies that understand the special requirements of each loan.
• If a customer is seeking a hotel loan, the mortgage company will
handle the contact with a secondary-market investor most
interested.
• The mortgage company serves as a loan broker, negotiating the
loan for an investor.
• The investor then funds the loan at closing and handles the
servicing.
18
Selling Mortgage-Backed Securities
• These sales involve converting loans into mortgage-backed
securities.
• Prior to the mortgage crisis, most loan originators sold their
loans to large loan poolers such as an investment bank or
Fannie Mae.
• One method is to place a multimillion-dollar block of mortgage
loans in the care of a trustee, such as an authorized bank.
• Then the mortgage company issues a series of certificates backed
by the block of loans, which is the collateral for the securities.
• The certificates are sold to investors and the money received
from these certificates is used to reimburse the mortgage
company.
• This procedure is often identified as securitizing mortgages.
19
Mortgage Company Income
• Profit margins are narrow in handling mortgage loans.
• Mortgage companies make little, if any, money from the
discount, since that amount passes to the loan purchaser as
part of the cost of money.
• What the mortgage company is really doing is buying a piece of
paper—the mortgage note—when it funds the loan at closing.
• Then the note is sold to a secondary-market purchaser.
• The difference between what is funded at closing and what the
mortgage company sells the note for is the amount it earns.
• Some lenders will charge a higher interest rate than market rates
to add additional profits called “yield spread premium.”
• The dependable income for loan originators comes from
various fees: application fees, origination fees, yield spread
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premium, and servicing fees.
Application Fee
• Loan originators normally charge a nonrefundable
application fee at the time an application is taken.
• The fee covers certain costs incurred in screening an
application.
• The fee is not regulated (except for HUD/FHA and VA) and
is charged by almost all originators, not just mortgage
companies.
• For residential loans, the fee is in the $150 to $500 range,
while fees for commercial loans are often based on the
size of the loan.
21
Origination Fee
• A separate charge of one to two percent of the loan amount.
• It is a charge incurred for assembling a loan package and
making the decision to accept or reject the loan.
• The charge is for services rendered but is tax deductible for
the borrower if certain rules are followed.
• It is a separate charge from the discount, which is also tax
deductible, but the two are not always differentiated when loan
costs are quoted.
• Mortgage personnel should disclose the distinction to borrowers.
• Mortgage companies usually split the fee, with half going to the
loan representative who contacts the borrower and takes the
loan app.
• This fee is considered the “commission” earned by the
representative and is not paid if the loan fails to close.
22
Servicing Fee
• The charge made for handling the loan after it has been funded.
• Services involve collecting and accounting for payments,
handling the escrow account, and following up on delinquent
accounts.
• The fee amounts to 0.25 to 0.50 percent of the loan balance.
• Servicing large blocks of loans can be a lucrative business and
specialized companies have developed to perform just this
function.
• Sometimes a loan originator accumulates several billion dollars
in loans to service and will sell a portion of the block to acquire
cash.
23
Servicing Fee (continued)
•
The Great Recession led to the rise of a new type of loan
service operation known as special servicers or default
servicers.
•
They can be free-standing firms specializing in servicing
hedge funds or mortgage assets.
•
Another type of loan special servicer is a privately
managed investment company that provides integrated
full life cycle mortgage loan servicing.
•
These new special servicers have a much higher fee
structure.
24
Loan Servicing Disclosure Notice
• The servicing function may be transferred at any time.
• Scam artists using unauthorized or stolen lists of borrowers
can direct payments to a post office box, skim the collections,
and disappear.
• Originators now provide borrowers with a servicing disclosure
notice.
• The notice must include an explanation of two points:
1) the possibility that loan servicing may be transferred
2) the rights of a borrower should such a transfer occur
• Must provide a borrower with an estimate, expressed as a
percentage, of the possibility of transfer.
• Notice must be sent to the borrower not less than 15 days prior
to any transfer, and the new servicing company must confirm
the change within 15 days after.
• A toll-free number must be provided for the borrower to
contact the servicing company.
25
Automated Loan Underwriting
• An explosive growth in mortgage originations has led
to the use of computer programs using artificial
intelligence in the analysis, and even the final
approval, of residential loans.
• HUD has encouraged the greater use of
computerized loan underwriting, as it can lower costs
and give more unbiased analysis.
• This method has brought an increase in the use of
credit scoring and offers ways to expedite appraisals.
• Because of the many advances in technology, it is
now possible for an individual to negotiate a
mortgage loan on the Internet.
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Other Primary Market Lenders
• The opening of the secondary market and the
wide acceptance of mortgage-backed securities
have encouraged many newcomers.
• The next section discusses the major players in
this field, who are not subject to banking
regulations.
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Other Primary Market Lenders
(continued)
Nonbank Lenders
These include such major operators as ING Group, Ally
Financial, Honda Financial Services, GM Financial, and the
retail finance division of GE Capital.
Investment Bankers
As many investment bankers expand into handling various
money market accounts, retirement funds, and even checking
accounts, some have entered mortgage loan origination.
Edward D. Jones, Charles Schwab Company, Merrill Lynch, and
Raymond James & Associates are all examples of this kind of
lender.
Finance Companies
Many small loan companies, such as HSBC Finance
Corporation, that formerly made mostly unsecured personal
loans have expanded into mortgage lending as a better method
of securing their loans.
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Other Primary Market Lenders
(continued)
Home Builders
KB Home, Pulte Homes, D. R. Horton and others have entered
the market through subsidiaries that process loans and sell
them into mortgage pools.
Real Estate Brokerage Firms
Companies that have developed national real estate brokerage
operations through direct acquisitions or franchise networks
have entered the loan origination business. Such companies as
Century 21 and Prudential Real Estate are now able to offer
mortgage loan services in their own offices.
Internet
The newest method of negotiating a mortgage loan is through
contacting a mortgage loan site on the Internet. An individual
who may have a tarnished credit record and wants to remain
anonymous, a person living in a rural area who wants to avoid
traveling a long distance, or maybe even someone with an
excellent credit record who feels more comfortable with an
29
impersonal interview are all lured to the Internet.
Other Primary Market Lenders
(continued)
Computerized Loan Origination (CLO)
Today CLO is one method used by real estate brokers to
assist buyers in negotiating a loan to purchase a property.
Current HUD rules allow a person or company who initiates
the loan and assists in helping a borrower furnish the
necessary information to earn a fee that is reasonably
commensurate with the work performed.
Pension Funds
During the past decade, pension funds have become large
investors in mortgage loans. By far the most common
method is through the purchase of mortgage-backed
securities. In this way investors avoid the management
problems associated with individual mortgage loans and
are able to treat such investments as just another kind of
security. However, a few pension groups, particularly
those operated by state agencies and by labor unions,
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offer home loan programs as primary lenders.
Other Primary Market Lenders
(continued)
Real Estate Investment Trusts (REITs)
• Must be structured as a corporation, trust, or association.
• Must be managed by a board of director or trustees.
• Must have transferable shares or certificates of interest.
• Must be formed as an entity that is taxable as a corporation.
• Financial institutions and insurance companies cannot be a REIT.
• Must have joint ownership with at least 100 persons owning the
stock.
• Must not have more than 50% of shares held by five or fewer
individuals.
• 75% of total assets in real estate or in real estate–backed assets.
• At least 75% of gross income must be from rents or mortgage interest.
• No more than 25% of assets may consist of stock in taxable
subsidiaries.
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Other Primary Market Lenders
(continued)
Individuals
Many individuals make mortgage loans, sometimes with
reluctance.
Title Companies
May act as primary sources in lending their own funds.
Universities, Colleges, and Hospitals
Many endowments take the form of land and other real
property, and these may require more expertise in the
mortgage loan field.
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Other Primary Market Lenders
(continued)
Foundations
Established primarily by corporations or wealthy families
as a means of continuing charitable activities.
Fraternal, Benevolent, and Religious Associations
Some of these organizations limit lending to their own
members and will provide low-cost loans to qualified
members.
Foreign Lenders
Foreign investments may take forms of direct loans made
to commercial real estate developers, investments by
banks, or direct investments by foreign sovereign wealth
funds.
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Government Loan Programs
• There are some programs that handle direct loans to
borrowers; that is, the agencies work in the primary
market.
• Many such programs require that the loan applicant first
attempt to borrow the money from private sources.
• Direct mortgage loan programs offered by the federal
government are almost all farm related.
• State- and municipal-sponsored loan programs are
mostly housing related.
34
Farm Credit System
• A borrower-owned network of farm lending banks under the
supervision of the Farm Credit Administration (FCA).
• The FCS is composed of four regional farm credit districts
owned by over a million American farmers and their cooperatives.
• The system makes long-term mortgage loans and short-term
crop loans through different organizations.
• Most of the financing is handled through the sale of six- to ninemonth securities, and some with two- to five-year coupon notes.
• Generally, loans are limited to 85 percent of the appraised value
of the property, with a term of not less than five years and not
more than 40 years.
• Interest rates for most loans apply a variable-rate plan based on
the FCS cost of funds.
35
United States Department of Agricultural
Development
• The Rural Development Housing and Community
Facilities Programs (RHS) holds another $181 billion
of the debt owed by farmers.
• Provides loans for farms, homes, parks, camping
facilities, hunting preserves, access roads, waste
disposal systems, and disaster areas.
• Also provides loan guarantees to help local lenders
extend credit needed for the growth and preservation
of jobs.
• It has expanded its traditional lending base to include
towns of up to 50,000, but it gives priority to towns of
less than 25,000.
36
Home Ownership Loans
• The Rural Development Service’s home loan program is
limited to rural areas and to low- and moderate-income
families unable to qualify for home financing in the
private market.
• Loans can be made up to 100% of the appraised value of
a house for a maximum term of 33 years (38 years for
those with incomes below 60% of AMI and who cannot
afford 33-year terms).
• Eligibility is limited to those with very low income, defined
as below 50% of the area median income (AMI); low
income is between 50% and 80% of AMI; moderate
income is 80% to 100% of AMI.
• One can visit http://www.rd.usda.gov/files/RDDirectLimitMap.pdf and click the Metropolitan Statistical
Area, or “MSA,” nearest one’s location to learn current
income limits listed by family size.
37
State and Local Government Programs
•
Many state and local housing agencies have developed
programs since the 1970s.
•
Some offer direct loans to qualified buyers.
•
Programs often offer downpayment assistance to lowincome first-time homebuyers and to finance multifamily
rental housing.
•
State entities often called agencies, authorities, or
development corporations.
•
Programs are funded by state bond programs backed by
mortgages.
38
Questions for Discussion
1.
Distinguish between the operations of a mortgage
banker and a mortgage broker. What are the five major
minimum standards that an independent mortgage
broker or loan officer must pass to be licensed with the
NMLS?
2.
What qualifications are necessary to become a
mortgage banker? Are there any special requirements
for mortgage lenders in your state?
3.
What is meant by loan servicing?
4.
Identify the principal sources of mortgage company
income.
5.
How does the Farm Credit System structure the
various agencies that handle oversight of the farm
mortgage lending function?
39
Questions for Discussion
(continued)
6.
Describe the qualification for the Rural Development
Service’s home loan program.
7.
Explain the origin and purpose of Real Estate Investment
Trusts.
8.
Name three primary market lenders that are not subject to
banking regulations.
9.
Describe a warehouse line of credit and who may use it.
10. Are there any good sources of mortgage money available
in your locality outside of mortgage companies and
regulated lending institutions?
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