About Mortgages
The mortgage industry in the United States may be subdivided into several major segments, which are:
- Residential (or home) mortgages
- Multifamily residential mortgages
- Commercial mortgages (mortgages taken on real estate for businesses)
- Farm mortgages
The mortgage industry in the U.S. is enormous. At the end of 2005, there was in excess of $11.9 trillion worth of outstanding mortgage debt, of which residential home mortgage debt comprised the largest segment with over $9.1 trillion in outstanding debt [Note 1].
The next largest segment of the mortgage industry is the commercial segment which had almost $2 trillion of outstanding mortgage debt at the end of 2005. The commercial segment is followed up by the multifamily residential segment which had over $670 billion of outstanding mortgage debt. The smallest segment is the farm segment with just over $150 billion of mortgage debt at the end of 2005 [Note 1].
Types of Mortgage Business
Companies that are directly involved in the mortgage industry fall in to one of three broad categories:
- Mortgage Bankers
- Mortgage Brokers
- Mortgage Servicers
Mortgage bankers, sometimes also referred to as lenders or mortgage lenders, are companies that lend money to individuals or companies to purchase real estate. They are said to "originate" loans. A mortgage banker may hold a mortgage in their own portfolio or may sell the loan on the secondary market (see The Mortgage Lending Process below). Mortgage bankers may also service mortgage loans (maintain the loan accounts and collect mortgage payments). Some mortgage bankers may also broker the loans of other companies.
Mortgage brokers are companies that act as middlemen, bringing borrowers and mortgage bankers together. In essence, a mortgage broker sells the mortgage products of one or many (typically many) mortgage lenders. Mortgage brokers do not actually lend money, and they typically do not service mortgages.
Mortgage servicers are companies that collect mortgage payments (principal, interest), escrow payments (for taxes and insurance), and manage a borrower's mortgage and escrow accounts. Many mortgage bankers are also mortgage servicers. Many large mortgage bankers/servicers may service the loans of smaller lenders. Some companies only service mortgages and have nothing to do with the lending process.
Top mortgage originators would include Countrywide Financial, Wells Fargo, Washington Mutual, Chase Home Finance, and CitiMortgage. These companies are also the top servicers of mortgages [Note 2].
In addition to theses business, there are business that provide related products and services. These would include:
- Title insurance companies
- Companies that provide mortgage life insurance
- Companies that provide private mortgage insurance (PMI)
The Mortgage Lending Process
From the point of view of the consumer, the mortgage process is really pretty straight forward (although it may not seem that way when the consumer is involved in the process). The basic process is as follows:
- Shopping for a loan that meets the consumer's needs. In this phase, a consumer would compare many different types of loans, and then compare the terms and conditions, and interest rates for the type of loan that they settle upon.
- Pre qualifying for a loan. This is an optional step that many consumers go through prior to or while shopping for a house. In this step the consumer provides some basic information (employment, income, debt etc.) to a potential lender, who also "pulls" (obtains) the consumer's credit score (referred to as a FICO score - a score on a scale of 400 to 900 indicating bad to excellent credit). With these two pieces of information the lender can say whether or not the consumer is likely to qualify for a loan.
Typically lenders are looking for consumers with credit scores of 640 and above, a housing ratio of around 28% or better, and a debt ratio of around 36% or better. A housing ratio is what the consumer pays on a monthly basis for principal, interest, taxes (property) and insurance (home), referred to as PITI, divided by the consumer's monthly income. Similarly, a debt ratio is what the consumer pays on a monthly basis to service all debt (housing, credit card, car loans, student loans etc.) divided by their monthly income.
Pre qualification does not guarantee the consumer a mortgage loan. The only hard piece of evidence at this point is the credit score. All other information (income etc.) is unverified. For this reason, many consumers may skip over the pre qualification process and look to be pre approved for a loan while they are shopping for a home. These individuals go through the more rigorous process of applying for a loan - Applying for the loan. This is the paperwork part of the process. If a consumer is applying in a "traditional" manor (they are not applying for a reduced or no documentation loan), this step involves filling out an application (either paper or online), and providing documentation of employment, income, and assets.
- The loan approval process. This is what lenders refer to as "underwriting". A processed application can either meet the lenders criteria and be approved, it can be approved with conditions, an application can be returned for additional documentation and resubmission, or the application can be denied.
- The loan closing. This is what the lender may refer to as "settlement". This is the part of the process where the lawyers get involved preparing all of the settlement documents. Either the consumer, the consumer's attorney or other individual who has power of attorney attends the closing to sign all of the necessary documents. At the end of the closing, the consumer owns a home and owes a lender a significant amount of money - the amount of the home mortgage loan.
- Making mortgage loan payments. The final part of the mortgage process is the consumer's monthly or bi-monthly mortgage payments, typically consisting of principal, interest, and escrows for taxes and insurance. Lenders refer to this part of the process as "servicing".
From the lenders point of view, the entire process of obtaining mortgage applications, processing, underwriting, and closing is referred to as "loan origination". While some lenders do hold mortgages in their own portfolios, most lenders sell their mortgages on the secondary mortgage market. Two federally chartered government organizations, the Federal National Mortgage Association (FNMA or Fannie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac) purchase well over 20% of all U.S. mortgages. For this reason, most lenders comply with their underwriting guidelines. Fannie Mae and Freddie Mac then in turn resell the loans to private investors. This process allows the primary lenders to make a profit and quickly obtain more money to lend.
From the mortgage industry's point of view, the final major mortgage function is servicing the loans. As has been previously stated, servicing a loan is the process of collecting payments of principal and interest as well as escrows for taxes and insurance, managing escrow accounts, and managing consumer's mortgage accounts. Servicers may service their own loans as well as loans for other companies.
Mortgage Products Overview
There are really only fairly small number of loan types. Complexity is introduced because of the many different options or features that are available for the basic loan types.
One of the most basic things to understand about a mortgage is that it is either a conforming loan, or it is nonconforming or jumbo loan. Conforming mortgages are mortgages that fall within Fannie Mae and Freddie Mac mortgage limits (they are the only loans that FNMA and FHLMC will purchase from primary lenders). As of 2006, FNMA/FHLMC loan limits for first mortgages were:
- One-family loans: $417,000
- Two-family loans: $533,850
- Three-family loans: $645,300
- Four-family loans: $801,950
Note: One- to four- family mortgages in Alaska, Hawaii, Guam, and the U.S. Virgin Islands are 50 percent higher than the limits for the rest of the United States.
The loan limits for second mortgages were:
- $208,500
- In Alaska, Hawaii, Guam, and the U.S. Virgin Islands: $312,750
New loan limits typically get set in January of each year [Note 3].
The basic types of home mortgage loans are:
- Fixed rate mortgages (FRMs) or mortgages where the interest rate and principal and interest payment remain the same throughout the life of the loan.
- Adjustable Rate Mortgages (ARMs) or mortgages where the interest rate and the principal and interest payment vary throughout the life of the loan.
- Hybrid loans or mortgages that remain fixed for a period of time such as three, five, or seven years, and then adjust like an ARM.
- Graduated payment mortgages (GPMs) or mortgages that have a fixed interest rate, whose payments gradually increase over a predetermined time increments and then level off.
- Reverse annuity mortgages (Rams) or reverse mortgages that actually pay an annuity while equity in a house decreases. These are for individuals 62 years or older who are looking to tap the equity in their homes for living or other expenses.
- Balloon mortgages or mortgages where the the payment is usually calculated over a 30-year term but the balance actually comes due much earlier, such as 5 or 7 years.
All mortgages have a term, or the amount of time necessary to repay the loan. The most typical terms are 15 and 30 years, but 10, 20, and 25 year terms are not uncommon, and 40 year mortgages are also starting to appear on the market.
Government loans are simply mortgage loans that are insured or guaranteed by the federal government. They are most typically fixed rate or adjustable rate mortgages. Government loans account for 20% of all mortgage loans. There are three types of government mortgages:
- Federal Housing Administration (FHA) loans
- Department of Veterans Affairs (VA) loans
- Farmers Home Administration (FmHA) loans
There are also a class of mortgages that require reduced or no documentation. These are also referred to as Alt-A mortgages. These are typically standard fixed or adjustable mortgages with reduced documentation requirements. There are no documentation loans where a person is applying only on the strength of their credit score and down payment. There are also many variations on reduced documentation loans, such as stated income (SI), no income (NI) verification, no asset (NA) verification, no ratio (NR - referring to the debt ratio calculations), no employment verification (NE), and many combinations of the above. These loans are typically intended for self-employed individuals who may have trouble documenting their true income (or who just do not want to go through the hassle). They carry with them more risk for the lender, so they typically have higher interest rates than traditional prime, or A grade loans.
Finally, there are secondary mortgages. These are mortgages that have a lien position behind the primary mortgage on a residence. These come in two forms:
- Secondary loans which are similar to primary mortgages.
- Home equity lines of credit (HELOC) which are more like credit cards. You are approved for an amount, but you draw upon the line of credit when you need it and pay it back in a manor similar to credit card payments.
Interest Rates Overview
Several things go into what interest rate a lender will charge to lend a consumer money to purchase a home. The first factor for interest rates is the overall economy and state of the debt market. Federal Reserve Board monetary policy (the prime rate etc.) can be very influential. Simply put, what a lender can borrow money for, and what the market will bear for them to charge helps to set a range for home loans at any given point in time.
After general credit market conditions, the risk assumed by the lender dictates where within the market range a particular loan's interest rate may be. Generally, lower credit scores, greater indebtedness, lower documentation provided, and strange or non-traditional borrowing requests introduce greater degrees of risk for the lender, who in turn charges higher interest rates for the loans.
An individual may buy-down the interest rate on a loan by paying points up front (a point is equal to 1% of the value of the loan). Points are in essence pre-paid interest to buy down the rate on the loan.
Finally, adjustable rate mortgages rates are typically driven by some index that is a measure of general interest rate trends. COFI, LIBOR, and Treasury Bill rates are some common indices used to help set ARM rates. Lenders charge a premium over the index rate (referred to as a margin). The rate charged to the consumer adjusts periodically by the terms of the loan as the index moves up and down.
Major Mortgage Organizations
Following are a few of the major mortgage organizations in the United States:
In addition to these, most states have their own mortgage bankers association, association of mortgage brokers, as well as state agency or organization responsible for licensing mortgage bankers and/or mortgage brokers - which is typically the Division of Banks.
Search for Mortgage Information
Add this search engine to your personalized Google homepage:
Notes
[Note 1] Source - Board of Governors of the Federal Reserve System
[Note 2] Source - National Mortgage News
[Note 3] Source - Fannie Mae
