The mortgage market is a dynamic landscape composed of various key players, each serving a crucial function in the ecosystem. Originators, such as Banks, Retail Lenders and Mortgage Brokers, initiate the loan process by helping borrowers secure financing. Servicers then manage the day-to-day administration of these loans, including collecting payments and handling customer inquiries. Aggregators purchase loans from originators to pool them together, creating mortgage-backed securities (MBS). Securities dealers facilitate the buying and selling of these securities, ensuring liquidity in the market. Finally, investors, including institutional and individual entities, purchase MBS, providing the capital necessary to sustain the flow of credit in the housing market. Together, these players form a complex network that drives the mortgage industry, each contributing to the overall stability and functionality of the market.
Originators:
A mortgage originator is an institution and/or individual that works with a borrower to complete a home loan transaction. A mortgage originator is the original mortgage lender and can be either a mortgage broker, bank or retail mortgage lender. Mortgage originators are part of the primary mortgage market and must work with underwriters and loan processors from the application date until closing to gather the necessary documentation and guide the file through the approval process.
In general, mortgage originators make money through the fees that are charged to originate a mortgage and the difference between the interest rate given to a borrower and the premium the secondary market will pay for that interest rate. As we’ll learn, it’s a common misconception that the originating company is primarily in the business of earning a profit by collecting interest on loans. To learn more specifically about how Mortgage Brokers receive compensation, visit our Insights article here.
Here are the main steps of the origination process:
Obtaining The Client:
Before the pre-approval process for mortgages can begin, companies must first attract potential borrowers through marketing efforts and outreach strategies. Large banks and retail lenders often have considerable marketing budgets and resources to obtain potential clients whereas most Mortgage Brokers rely on referrals and local community outreach/networking. The ability to obtain and retain clients is arguably the most important and valuable aspect of the entire mortgage market.
Pre-Approval Application
This is a formal process in which a lender or mortgage broker evaluates a potential borrower's creditworthiness based on a thorough review of their financial history and current financial situation. The lender/broker will issue a pre-approval letter stating the maximum loan amount for which the borrower qualifies.
Final Application
A Uniform Residential Loan Application (Form 1003) is completed, usually electronically, through the Lender or Brokers Loan Origination System. Then the Official Loan Estimate and other Initial Disclosure documents are signed.
Processing
The processor will verify all the information provided in your application and collect all required documentation in preparation for submitting the loan to Underwriting. Sometimes the Loan Officer will process their own loans or outsource it to a third party/assistant.
Underwriting
Underwriting reviews the application, checking for accuracy and completeness. They ensure the borrower meets all the guidelines set by both the lender and the type of loan program (Conventional, FHA, VA, USDA, ETC).
Closing/Funding
At least three business days before closing, borrowers receive a Closing Disclosure (CD), which outlines the final loan terms and closing costs. They'll sign numerous documents, including the promissory note, mortgage agreement, and closing disclosure. Once all documents are signed, the lender funds the loan. The primary distinction difference between Mortgage Brokers and Banks/Retail Lenders is that Brokers don’t fund the loans.
Servicers:
Mortgage Servicing Rights (MSRs) are the rights to handle the day-to-day management of a mortgage loan. This includes collecting monthly payments from borrowers, managing escrow accounts, providing customer service, and handling delinquencies and foreclosures. The entity that owns the MSRs is known as the mortgage servicer, and this isn’t always the same company as the Originator. Mortgage Servicing Rights are a separate asset on a mortgage company’s balance sheet and are frequently bought and sold as we’ll discuss below.
It’s important to understand that due to the way the mortgage market works, the entity servicing your loan doesn’t mean you should necessarily refinance with them. Part of the reason they retain or purchase Mortgage Servicing Rights is to convince consumers they have a special advantage when it comes to refinancing. The reality is that when you refinance, you’re paying off the original loan and then starting the Origination process over again with a new loan.
Creation of MSRs:
When a lender originates a mortgage loan, they can choose to retain the servicing rights or sell them to another entity. You will usually see whether they plan to retain or transfer on the last page of your Loan Estimate as well as other Closing documents. This decision is often influenced by the lender's business model and financial strategy. It’s also common for an Originating Lender to retain the Servicing rights for only a limited time before selling the rights to another Lender/Servicer.
Sale Types of MSRs:
Whole Loan Sales: Sometimes, lenders sell both the mortgage loan and the servicing rights to another institution.
Retained Servicing: In other cases, lenders sell the mortgage loan but retain the servicing rights, continuing to manage the loan.
Separate MSR Sales: Lenders can also sell the MSRs separately in the secondary market. MSRs are valuable assets, and their value is determined by the present value of the expected future cash flows from servicing the loans.
The Secondary Market for MSRs
The secondary market for MSRs is where these rights are bought and sold among financial institutions. Here’s how it works:
Valuation: The value of MSRs depends on several factors, including the interest rate environment, prepayment speeds, delinquency rates, and servicing costs. MSRs are more valuable when interest rates are stable and prepayment speeds are low.
Trading: MSRs can be bought and sold as part of large transactions involving multiple loans. Specialized firms, such as mortgage servicers and investors, participate in this market.
Risk Management: Investors in MSRs must manage various risks, including interest rate risk, prepayment risk, and credit risk. Effective risk management strategies are crucial for maintaining the value of MSRs.
Importance of MSRs in the Mortgage Industry
Revenue Stream for Lenders: MSRs provide a steady stream of revenue for lenders and servicers through servicing fees, float income from escrow accounts, and ancillary fees such as those required when submitting a loan recast request.
Operational Efficiency: Specializing in mortgage servicing allows firms to achieve economies of scale, reducing per-loan servicing costs and improving profitability.
Market Liquidity: The ability to trade MSRs adds liquidity to the mortgage market, enabling lenders to manage their balance sheets more effectively and to continue originating new loans.
Aggregators:
Aggregators purchase newly originated mortgages from smaller originators and, along with their own originations, form pools of mortgages that they either securitize into private-label mortgage-backed securities (by working with Wall Street investment banks) or form agency mortgage-backed securities (by working through GSEs such as Fannie Mae, Freddie Mac and Ginnie Mae). Aggregators perform a highly complex and specialized service and therefore earn fees from the Originating Lender selling the loan.
Similar to originators, aggregators must hedge the mortgages in their pipelines from the time they commit to purchasing a mortgage through the securitization process and until the MBS is sold to a securities dealer. Hedging a mortgage pipeline is a complex task due to fallout and spread risk. Aggregators make profits by the difference in the price that they pay for mortgages and the price for which they can sell the MBS backed by those mortgages, contingent upon their hedge effectiveness.
Securities Dealers:
After an MBS has been formed (and sometimes before it is formed, depending upon the type of the MBS), it is sold to a securities dealer. Most Wall Street brokerage firms have MBS trading desks. Dealers frequently use MBSs to structure CMOs, ABSs, and CDOs. These deals can be structured to have different and somewhat definite prepayment characteristics and enhanced credit ratings compared to the underlying MBS or whole loans. Dealers make a spread in the price at which they buy and sell MBSs and also look to make arbitrage profits from the way in which they structure the particular CMO, ABS, and CDO packages.
Investors:
Of all the mortgage investors, the GSEs (Fannie Mae, Freddie Mac, Ginnie Mae) have the largest portfolios. Foreign governments, pension funds, insurance companies, and banks typically invest in highly rated mortgage products. Certain tranches of the various structured mortgage deals are sought after by these investors for their prepayment and interest rate risk profiles.
Investors buy mortgages (or mortgage-backed securities) for the same reason they invest in most debt instruments: income. Specifically, income from the interest generated by the loan—steady money coming in every month (or whichever way the mortgage owner makes their payments). The regularity of this income can be appealing to institutional investors, such as pension plans, insurance annuity companies, and mutual funds, that make recurring payments to account holders and clients.
Most mortgage-backed securities are considered to be of high credit quality, often higher than that of corporate bonds, especially if they are agency mortgage-backed securities (that is, guaranteed by the government or government-sponsored agencies such as Ginnie Mae, Fannie Mae, or Freddie Mac). Yet mortgage-backed securities have provided yields that are higher than other low-risk bonds, like Treasuries of comparable maturities.
Key Takeaways:
A:) Origination is only one part of the mortgage market. Wholesale Lenders can compensate Mortgage Brokerages for originating loans while still earning revenue through other sources.
B:) Mortgage Brokers can access such a wide variety of lenders in large part due to the uniformity in Underwriting guidelines set by the Investors and GSE's. The majority of underwriting (qualification) guidelines are not Lender specific.
C:) The original Lender and/or Servicer doesn't have an inherit advantage when it comes to refinancing.
D:) Regardless of what company originates your mortgage, chances are it will be securitized and sold to an investor.