If you follow the headlines or have tried to refinance, you’ll know that mortgage lenders have been swamped with applications. With so much business how could there be financial issues? This week we dive into the weeds to expose the next government bailout of the mortgage industry.
In the mortgage world there are 3 different players: Originators, Servicers, and Note Holders. All 3 are necessary to the orderly system of our modern mortgage market. It is this system that has allowed for the greatest amount of liquidity in the world. But with the unprecedented amount of mortgage volume occurring right now, the system is showing cracks. I’ll first describe each component, then delve into the issue.
Origination is the “lending” part of the mortgage process. When you apply for a mortgage loan you are dealing with an originator. Banks, Brokers, and large national institutions like Quicken, are all originators. Their job in the lending process is to take the loan from the application to funding and recording your new loan. When your new loan is recorded at the Bureau of Conveyances, the originator “sells” your loan to get their money back to lend out again, plus earn a commission from the buyer of your mortgager debt. Originators make money by originating mortgages and selling them to Note Holders. They do not make money from the interest you pay.
When your loan is sold by your originator to the Note Holder, a servicer is required to collect your monthly payments, pay your escrowed taxes and insurance, and pay the note holder their monthly principal and interest payment. Servicers charge the note holder a fee for their work. If you think about it, this is an industry where the term “economy of scale” is a great example. If a servicer sets up an office of people to do all the collections and disbursement, the more loans you service, the more money you’ll make. You can expand out the number of loans you service significantly while maintaining the same workforce.
Note holders are the people that buy your loan from the Originator. In exchange for your low-risk long-term debt, the note holder pays the originator the entire sum of your mortgage loan, plus pays them a commission for this low risk investment. Note holders in exchange make money from the interest you pay on your note. They do have ongoing costs. They have to pay a servicer to collect the payments on the mortgages they hold, and to ensure the taxes and insurance bills are also paid.
The Crisis Hitting the Mortgage World Right Now…
The commission the Note Holder pays the Originator is calculated based on risk and a calculated length of time your mortgage loan is expected to last. Although you have a 30-Year loan, most mortgages never go 30 years. The average length of time used to be about 7 years.
When rates dropped significantly because of the economic impact of the coronavirus, millions of people looked to take advantage of low rates and refinance. This set off a chain of events that has had a hugely negative effect on the mortgage industry.
Note holders who paid a commission to originators for loans they expected to earn interest from for years to come, have seen those loans get paid off early. The note holders may actually lose money after they account for the commission pay out when they bought the loan, plus the fees they paid for the servicer to service the loan.
Servicers are the hardest hit right now. When a servicer obtains your mortgage loan to service, they pay the note holder an upfront fee for the right to service your loan. It generally takes 3 years for the servicer to make back the upfront fee they paid for the servicing rights of your loan. When a borrower refinances in under 3 years, the servicer loses money. To complicate matters even more, the portfolio of loans a servicer has is considered an asset. As with all assets, the servicer uses this asset as collateral and borrowers against it. Now that mortgages are being refinanced so quickly into their 30-Year term, the value of those portfolios has dropped drastically. Servicers are being hit with margin calls and have to fork out cash to satisfy the people they owe. But the most drastic turn of events for servicers has to do with borrowers not paying their mortgage payments because of the current crisis. Servicers are responsible to make the monthly payments to the note holders – regardless of non-payment by the borrower!
Originators are also having problems right now. Many of them own Servicing divisions or subsidiaries. That’s creating loses for their bottom line. But their biggest problem is one that will directly impact borrowers the most – lack of investors wishing to buy mortgage debt right now. Investors (Note Holders) are uncertain of how long these loans will last before they are refinanced too. They are also concerned about mortgage defaults. Additionally, servicers are not willing to pay a premium to service new loans.
The result of this mess detailed above, and how it affects you the borrower, is that many loan programs are functionally gone – and many more are about to make their exit. There’s no investor appetite for any of the exotic loans like the bank statement programs and alternative documentation loans. But it goes deeper than that. There’s no investor appetite for many government programs like jumbo VA, FHA, and USDA loans. Loan guidelines are also starting to tighten up. Minimum credit standards have been raised to eliminate borrowers with credit scores below 640 (it used to be 620). I also suspect some of the 3% down programs will be gone soon too.
While the circumstances are quite different from the financial meltdown of 2008, I do see some similarities. If you have plans to purchase a home, or have any thoughts of refinancing, now is the time to engage a seasoned mortgage professional that understands what’s happening in the financial world and has the resources to place your loan with multiple lenders – both national and local. If your primary goal is to close your transaction, the lowest rate should not drive your decision on who to use in this market environment.