How the American Mortgage Machine Works

Perhaps the original investors are the most familiar players for investors. They sit at the forefront of the process, and in many cases deal directly with borrowers. But for mortgages with typical terms and sizes, they are usually not the player who ultimately owns the loan.

U.S. through government-sponsored ventures. The housing market’s unique system of taxpayer support is one of the main reasons. Fanny May FNMA 1.27%

And Freddie Mac FMCC 0.87%

Buys loans from startups, guarantees them and resells them to agency mortgage securities investors. So in turn, the economics of many origins are ultimately done by loans produced and sold by Fanny or Freddie. This business model also avoids the risk of lending and requires less capital, which in turn attracts investors.

But selling a loan is rather complicated. For anyone else to buy or trade a loan negotiated by a third party, much needs to be done to earn a 30-year mortgage. Beginners mainly sell in a certified pool of mortgages arranged in half-point buckets of interest rates, such as 2.5% or 3%. Investors buy pieces of the bridge in the form of securities.

It is not the same as what the borrower pays. A 3% mortgage can end up in a 2% pool. This is because in order to further certify the loan, some parts of the interest pay for other conversion services. One part is for Fanny or Freddie, various adjustments depending on their original cost plus individual mortgage to guarantee the mortgage. The second part is for the servicers, who handle the collection from the borrower and then pay the investors, tax officials and others.

In return for this long-running flow of fees, service providers bear certain risks. For one, when interest rates fall, more mortgages are refinanced and prepaid sooner, causing service providers to lose that flow of payments. Servers also cover some missed payments before the mortgage actually defaults. In an economy where a lot of people lose payments, it can sting. An increase in payment deferrals during the epidemic, for example, led to a drastic reduction in servicers.

Even start-up businesses may have to use private mortgage insurance if the loan-to-value ratio is too high for the guarantor, perhaps because the borrower puts it down to less than 20%. Borrowers can pay these fees directly or indirectly through higher mortgage rates.

Even after paying for servicing and credit risk, an originator cannot always calculate the estimated sale price for each mortgage. Relative prices between mortgage rates or buckets can move during long closing periods, but borrowers are like “locks” on offered rates. There is a huge market for the delivery of futures mortgages, known as the TBA market, or “to declare”, which is used to effectively hedge the risk of that rate for the lender. But there is a cost that can vary depending on how long the defense lasts.

Vishal Garg, chief executive of digital homeowners Better, explains that the business’s emerging technology component is consistent with how data and analytics are used to sell hedges at rates offered on mortgages. “By matching the final investor demand with the customer you can become a better participant in the market,” he says. “Traditional loan officers can’t reflect on all scenarios.”

Beginners have some natural counterparts that take interest-rate risk. The demands of investors, such as mortgage real-estate investment trusts, are informed by how much affordable funding they provide themselves, helping drive pricing.

One major route rate exposure is the speed at which people prepay. This in turn can affect what investors are willing to pay, as the securities obtained from those mortgages essentially become shorter lifespans. While many people enjoy the benefits of early volume even when refinancing, they may earn less when selling mortgages. Of course, when the Federal Reserve buys mortgage securities, and when other fixed-income asset rates are very low, the initial profits from mortgage sellers can be very large.

Smart investors will understand how changes in the market affect their portfolios.

Write to Telis Demos at [email protected]

Improvement and amplification
Start-ups will have to use private mortgage insurance if the loan-to-value ratio is too high for the guarantor. An earlier version of this article incorrectly stated that beginners would have to use private mortgage insurance if the loan-to-value ratio was too low for the guarantor. (Retrieved 3 January)