Mortgage Companies

6162

6163

INDUSTRY SNAPSHOT

The American Dream is intricately tied to home ownership, which by the twenty-first century was intricately tied to mortgage companies. While calling mortgage companies the gatekeepers of the American Dream may be a bit hasty, it is safe to say that mortgage companies represent a central component of the nation's housing and loan markets, and in their behavior increasingly resemble players in other financial sectors.

Companies in this industry are generally subsidiaries of large financial institutions, but mortgage companies themselves do not engage in banking functions such as accepting deposits or offering checking accounts. They concentrate specifically on mortgage loans. But within that market there is a great deal of variation, a factor that was becoming more pronounced as industry competition heated up. Whereas mortgage companies traditionally focused on providing mortgages to customers with credit difficulties, that business was by the middle years of the first decade of the 2000s simply a hot niche market in an industry increasingly dominated by mortgage specialists.

The industry enjoyed the largest refinancing boom in its history between 2001 and 2003, but industry analysts cautioned that the early years of the first decade of the 2000s were in many ways a period of unsustainably happy times for mortgage lenders. With loan and refinancing demand exceptionally strong alongside rock-bottom interest rates, mortgage companies paid little attention to customer retention. Heading into the late years of the first decade of the 2000s, industry activity was well below that of the early years of the decade. Following the record year of 2003, the mortgage industry cooled off in 2005 and into 2006 as interest rates increased and home values were no longer skyrocketing.

The industry faced an economic slowdown, including a cooling housing market, heading into late 2006. According to the Mortgage Bankers Association (MBA), housing starts declined in July 2006 for the fifth time in six months. There were other economic cues as well, including a drop in building permits, which dropped for six consecutive months. Additionally, the Conference Board's Leading Economic Indicators index declined for the fourth time in six months in July, signifying that a substantial drop in economic growth was expected during the second half of the year. In the wake of these conditions, the MBA indicated that optimism among homebuilders was at the lowest level since February 1991. Souring economic conditions and rising interest rates also contributed to a bleak outlook in the area of mortgage foreclosures, which Harvard University Law Professor Elizabeth Warren predicted would nearly triple from 2005 to 2006, reaching 1.2 million.

ORGANIZATION AND STRUCTURE

Many consumers may still be confused by the plethora of lending sources. Basically, however, people who shop for mortgage loans can go to one of three different types of lenders. First, there are the traditional financial institutions and their affiliates, which include most banks, thrifts (savings banks or saving and loan associations), and credit unions, nearly all of which make mortgage loans. Sometimes the financial institution itself offers the loan; sometimes the loan is offered via a mortgage company owned by the institution. If a bank directs a customer to a loan office somewhere else, chances are that office will be in a mortgage company owned by the bank. Financial institutions generally underwrite their own loans. That is, they use their own assets to fund the loan. Banks and thrifts may hold the new loan in their own portfolio until it is paid off (sometimes as long as 30 years), or they can sell the loan into the broader secondary market for mortgage loans.

The second group consists of the more specialized mortgage bankers and mortgage companies. These institutions offer the same sort of mortgage loans as financial institutions but without any other banking services. They, too, underwrite their own loans. The national mortgage companies in particular are fairly innovative about creating mortgage products with varying terms, floating interest rates, and other features that attract a wider range of customers.

According to the Mortgage Bankers Association of America (MBA), mortgage banking companies are the largest group of home mortgage lenders, followed by commercial banks and savings and loans. Mortgage banking companies operate mainly in the secondary mortgage market, using government and private institutions such as Fannie Mae, Freddie Mac, and Ginnie Mae.

Finally, there are mortgage brokers, which are mortgage banks in that they are not financial institutions and can be part of national companies. But there is one important distinction: mortgage brokers do not provide the money to make their loans. Instead, they play a matchmaking role by putting borrowers in touch with loan sources for a fee. Especially if a borrower has had credit problems in the past, a broker can be helpful in locating more flexible lenders. A broker makes its money by collecting a fee from the lender, the borrower, or both. In the best of circumstances, the lender and the broker split the points (the fees the borrower pays), so it should not cost more to borrow through a broker.

Mortgage firms account for about two-thirds of all originations. The second most important group by volume of mortgages is commercial banks, followed by the thrift industry (such as savings and loan associations), which as recently as 1990 dominated the industry. Other mortgage lenders include credit unions and life insurance companies.

Banks and thrifts may hold or sell newly originated mortgages, but mortgage companies generally sell their new loans almost immediately, often at the end of each month. This process involves what is known as the secondary mortgage market, in which large numbers of individual loans are bundled together according to characteristics such as their term in years and their interest rate. This large bundle is then used as the basis for a security or bond that is backed by the predictable payoff schedules of the underlying mortgages. These securities are then sold on the open market, normally to pension funds and other institutional investors who consider them a reliable long term investment.

This process of "securitization" of mortgages has two profound effects on the market. First, since the secondary market makes cash available to buy up mortgage loans, it permits the influx of more money into the mortgage market. This action in turn frees up more money for loans to the consumers and is thus particularly helpful in financing loans at the lower end of the market, where credit histories may be suspect. The other important effect of securitization has been the growth of mortgage companies. Since these firms lack the deep pockets of banks and thrifts, they could not possibly bear the risks involved in maintaining each of these loans in their own portfolio. By selling off the loan (and the attendant risk) to the secondary market, mortgage companies can provide a vital service to the consumer at little or no risk to themselves. This arrangement has fueled the rapid growth of private mortgage companies, which in turn has meant more choices for consumers.

The volume of mortgages sold into the secondary market varies with changes in the volume of fixed rate lending (as opposed to variable rate loans). The higher the percentage of...