 Understanding the Mortgage Loan Market
The mortgage business is a complicated
and ever-changing industry. It is important that
you understand how the mortgage market works and
how the lenders make their profit. In doing so,
you will gain an appreciation of loan programs
and why certain loans are offered by certain lenders.
INSTITUTIONAL LENDERS
The first broad category of distinction
is institutional versus private. Institutional
lenders include commercial banks, savings and
loans, credit unions, mortgage banking companies,
pension funds, and insurance companies. These
lenders generally make loans based on the income
and credit of the borrower, and they generally
follow standard lending guidelines. Private lenders
are individuals or small companies that do not
have insured depositors and are generally not
regulated by the federal government.
PRIMARY VERSUS SECONDARY MARKET
First, these markets should not
be confused with first and second mortgages. Primary
mortgage lenders deal directly with the public.
They “originate” loans, that is, they
lend money directly to the borrower. Often referred
to as the “retail” side of the business,
lenders make a profit from loan processing fees,
not the interest paid on the loan.
Primary mortgage lenders generally
lend money to consumers, then sell the mortgage
notes (in large packages, not one at a time) to
investors on the secondary mortgage market to
replenish their cash reserves.
The largest buyers on the secondary
market are the Federal National Mortgage Association
(FNMA or “Fannie Mae”), the Government
National Mortgage Association (GNMA or “Ginnie
Mae”) and the Federal Home Loan Mortgage
Corporation (FHLMC or “Freddie Mac”).
Private financial institutions such as banks,
life insurance companies, private investors, and
thrift associations also buy notes.
MORTGAGE BROKERS VERSUS MORTGAGE BANKERS
Many consumers assume that “mortgage
companies” are banks that lend their own
money. In fact, a company that you deal with may
be either a mortgage banker or a mortgage broker.
A mortgage banker is a direct lender;
it lends you its own money, although it often
sells the loan to the secondary market. Mortgage
bankers (also known as “direct lenders”)
sometimes retain servicing rights as well.
A mortgage broker is a middleman;
he does the loan shopping and analysis for the
borrower and puts the lender and borrower together.
Many of the lenders through which the broker finds
loans do not deal directly with the public (hence
the expression, “wholesale lender”).
CONVENTIONAL VS. NON-CONVENTIONAL
“Conventional” financing,
by definition, is not insured or guaranteed by
the federal government. Conventional loans are
generally broken into two categories: “conforming”
and “non-conforming.” A conforming loan
is one that conforms or adheres to strict Fannie
Mae/Freddie Mac loan underwriting guidelines.
Conforming loans are a low risk
to the lender, so they offer the lowest interest
rates. Conforming loans also have the strictest
underwriting guidelines.
Conforming loans have three basic
requirements:
1. Borrower Must Have a Minimum
of Debt: Lenders look at the ratio of your monthly
debt to income. Your regular monthly expenses
(including mortgage payments, property taxes,
insurance) should total no more than 25 to 28%
of gross monthly income (called “front end
ratio”). Furthermore, your monthly expenses,
plus other long-term debt payments (e.g., student
loan, automobile, alimony, child support) should
total no more than 36% of your gross monthly income
(called “back end ratio”). These ratios
can sometimes be increased if the borrower has
excellent credit or puts more money down.
2. Good Credit Rating: You must
be current on payments. Lenders will also require
a certain minimum credit score called a “FICO”
(http://www.myfico.com).
3. Funds to Close: You must have
the requisite down payment (generally 20% of the
purchase price, although lenders often bend this
rule), proof of where it came from, and a few
months of cash reserves in the bank.
NON-CONFORMING LOANS
Non-conforming loans have no set
guidelines and vary widely from lender to lender.
In fact, lenders often change their own non-conforming
guidelines from month to month.
Non-conforming loans are also known
as “sub-prime” loans, because the target
customer (borrower) has credit and/or income verification
that is less-than-perfect. The sub-prime loans
are often rated according to the creditworthiness
of the borrower – “A,” “B”,
“C” and “D.”
The sub-prime loan business has
grown enormously over the past ten years, particularly
in the refinance business and with investor loans.
Every lender has its own criteria for sub-prime
loans, so it is impossible to list every loan
program available on the market. Suffice it to
say, the guidelines for sub-prime loans are much
more lax than they are for conforming loans.
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