Real Estate Finance Unit 3

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Loan portfolio

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The set of loans that a financial institution, or other lender, holds at any given time

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Direct lender

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Deals directly with its customers and funds its own loans

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Primary mortgage

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The market in which borrowers and loan originators meet to negotiate terms and make real estate loans

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Lender

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The person who or company that makes mortgage loans, such as a mortgage banker, credit union, bank, or a savings and loan. Underwrites and funds the loan

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Third party originators (TPOs)

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Those who originate but do not underwrite or fund loans are called _________. Includes mortgage brokers and loan correspondents. TPOs package loans for lenders and are paid a commission when the loan is funded

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Fiduciary, Semi-fiduciary, or Non-fiduciary

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One method of classifying lenders is by their fiduciary responsibility toward their depositors and customers. The classifications are:

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Financial fiduciary

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An institution that collects money from depositors, premium payers, or pension plan contributors and makes loans to borrowers. Include commercial banks, thrifts, credit unions, life insurance companies, and pension plans. These lenders have a fiduciary responsibility to the owners of the funds. As a result, lending practices are carefully regulated by law in order to protect the owners of the funds.

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Depository institution

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A financial institution that is legally allowed to accept deposits from consumers. The main types are commercial banks, thrifts, and credit unions. Most financial fiduciaries are _________

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Portfolio lenders

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Larger banks and thrifts that lend their own money and originate loans to keep in their own loan portfolio are called ______________. This is because they originate loans for their own portfolio and not for immediate resale in the secondary mortgage market. Because of this, they do not have to follow Fannie Mae/Freddie Mac guidelines and can create their own rules for determining creditworthiness

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Commercial banks

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Are the all-purpose lenders. They receive deposits and hold them in a variety of accounts, extend credit, and facilitate the movement of funds. Make the widest range of loans, including loans for buying real estate, home equity loans, business loans, and other short-term loans. Even though they make a variety of loans, a major type of lending activity is for short-term (6 to 36 month) construction loans. They operate as retail lenders, wholesale lenders, or some combination of both

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Demand deposit

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A deposit that can be withdrawn at any time

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Compensating balances

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Some banks require commercial borrowers to keep a certain amount of money on deposit as a requirement of the loan agreement. These deposits are called _______. Deposits held as compensating balances by a bank do not earn interest. As a result, the lender’s earnings on the loan are increased. Typically, 10% of the loan amount

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Federal Deposit Insurance Corporation (FDIC)

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An independent agency of the United States Government. The FDIC protects depositors against the loss of their insured deposits if an FDIC-insured bank or thrift fails. FDIC insurance is backed by the full faith and credit of the United States Government

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Thrift

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An organization formed to hold deposits for individuals

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Types of Thrift Institutions

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Savings and loan associations
Savings banks
Mutual savings banks

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The shareholders (stock ownership) or by their depositors (mutual ownership)

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Any thrift can be owned by _____ or _______

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Mutual ownership

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Means that all the depositors share ownership in the savings and loan association, which is managed by a board of trustees. The depositors (investors) in S&Ls, savings banks, or mutual savings banks are paid dividends on their share of the organization’s earnings. Mutual organizations issue no stock

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Shareholders

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If the institution is organized as a stock institution, investors can become ______ by purchasing stock through their stockbroker

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Savings and loan associations (S&Ls

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Have played a major role in the economy by pooling the savings of individuals to fund residential mortgages. The first customers of S&Ls were depositors and borrowers

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Savings bank

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Described as a distinctive type of thrift institution because it can behave like a commercial bank or like an S&L. While savings banks are authorized to make mortgage loans, most specialize in consumer and commercial loans. However, they are active in purchasing low-risk FHA/VA and conventional mortgages from other mortgage lenders and mortgage companies. Since most savings banks are located primarily in the capital-surplus areas of the northeast and possess more funds than are needed locally, savings banks play an important part in the savings-investment cycle by purchasing loans from areas that are capital deficient. This flow of funds from areas with excess funds to areas with scarce resources helps to stimulate a healthy national financial environment

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Mutual savings bank

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Financial institution owned by depositors, each of whom has rights to net earnings of the bank in proportion to his or her deposits. The depositors’ return on their investment is determined by how successful the bank is in managing its investment

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Credit union

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Cooperative, non-profit organization established for banking purposes. Are owned and operated by their members. Usually, members are people in associations who share a common affiliation such as teachers, workers in the same field, government employees, or union members. Credit unions are exempt from federal taxation and sometimes receive subsidies in the form of free space or supplies from their sponsoring organizations. The members receive higher interest rates on savings and pay lower rates on loans. Both secured and unsecured loans are made at lower rates than other lenders can offer. The National Credit Union Association Board (NCUAB) supervises them and the federally insured National Credit Union Share Insurance Fund (NCUSIF) insures deposits

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National Credit Union Share Insurance Fund (NCUSIF)

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Insures the shares and deposits in a credit union

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Life Insurance Companies

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Life insurance companies obtain their funds from insurance premiums. Unlike the demand deposits of depository institutions, the premiums invested in life insurance companies are not subject to early withdrawal and do not earn a high rate of interest. Therefore, life insurance companies have vast amounts of money to invest. Life insurance companies do not usually originate individual loans in the single-family residential market. However, they are a major supplier of money for large commercial loans to developers and builders. Life insurance companies usually do not make construction loans but make takeout loans on large commercial properties. Loans made by life insurance companies have low interest rates and the lowest loan-to-value ratios (percentage of loan amount to appraised value). Life insurance companies also have stricter underwriting standards than other lenders. Even though they may deal directly with the borrower, they usually fund commercial loans through loan correspondents who negotiate and service the loans

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Takeout loan

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The long-term permanent financing used to pay off a construction loan

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Pension Funds

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Pension funds have huge amounts of money to invest. In fact, it is in the trillions. Both employer and employees contribute to employee pension plans. The contributions placed in a pension fund are used to purchase investments for the sole purpose of financing the pension plan benefits. The pension fund manager is responsible to invest the funds wisely and pay out a monthly income to retirees.

Like life insurance companies, pension funds are a direct source of funds for developers and large builders of commercial property. Pension funds also buy mortgages issued by banks. Large pension funds, such as those held by the state for the benefit of public employees, often guarantee the repayment of millions of dollars in bank loans used to build low-income and moderate-income housing. In exchange for the guarantee, these funds charge developers a percentage of the value of the loans they guarantee

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Pension plan

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A retirement fund reserved to pay money or benefits to workers upon retirement

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Financial semi-fiduciaries

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Non-depository lenders. A semi-fiduciary institution is never directly accountable to depositors, premium payers, or pension plan contributors. Therefore, they are less strictly regulated and can take more risks than financial fiduciaries. These semi-fiduciary lenders invest their own funds or borrowed funds. Mortgage companies and real estate investment trusts (REITs) are semi-fiduciary lenders

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Mortgage company/Mortgage banker

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A company whose principal business is the origination, closing, funding, selling, and servicing of loans secured by real property. They originate a majority of all residential loans. They lend their own money or money borrowed from warehouse lenders to fund loans. Their biggest role however, is to originate and service loans that they package and sell. After loans are originated, a mortgage company might retain the loans in the lender’s portfolio or may package and sell them to an investor. The sale of these loan packages provides added capital the mortgage company can use to make more loans to be packaged and sold, thus repeating the cycle. A mortgage company prefers to make loans that can be readily sold in the secondary market, such as FHA, VA, or conventional mortgages. Therefore, mortgage companies are careful to follow the required lending guidelines for these types of loans

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Warehouse line

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Since mortgage companies do not have depositors, they use short-term borrowing called ________. A revolving line of credit extended to a mortgage company from a warehouse lender to make loans to borrowers

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Warehouse Line of Credit

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Both the mortgage company and the warehouse lender want to create a profitable business relationship. The mortgage company borrows money on the warehouse line to fund a loan. The warehouse lender wires the borrowed money directly to a closing agent to fund the loan. The closing agent closes the loan, sends the original promissory note to the warehouse lender, and sends the other closing documents to the mortgage company. Then the mortgage company gets the closed loan package ready for an investor to purchase. When an investor purchases the loan, the warehouse lender sends the original note to the investor. The investor wires the purchase funds directly to the warehouse lender and not to the mortgage company. The warehouse lender uses the purchase funds to repay the advance for that particular loan, less any fees. The balance of the purchase proceeds are deposited into the mortgage company’s bank account, which is maintained by the warehouse lender. Each loan goes through this cycle

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Real estate investment trust (REIT)

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A security that sells like a stock on the major exchanges. REITs invest in real estate or mortgages. REITs are subject to a number of special requirements, one of which is that REITs must annually distribute at least 95% of their taxable income in the form of dividends to shareholders. REITs invest in equities, mortgages, or a combination of the two

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Real estate mortgage trust (REMT)

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Makes loans on commercial income property. Some REMTs specialize in buying and selling existing real estate loans. Their revenue is derived from the interest earned on the loans. A hybrid or combination REIT purchases equities and makes commercial loans

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Non-fiduciary lenders

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Non-depository institutions. In other words, they do not take deposits. Because they are relatively free from government regulations, these lenders follow their own underwriting guidelines and risk criteria.
They are private lenders that invest their own funds or borrowed funds. Some examples are private loan companies, private investors, and title companies

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Finance company

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A business that makes consumer loans for which household goods and other personal property serve as collateral. In addition, some private loan companies, such as Aames Financial Corporation and HSBC Finance Corporation, make home equity loans. The credit criteria may be more relaxed than the underwriting guidelines that traditional lenders follow, which allows those with poor credit to qualify. Because these real estate loans are in a junior position, finance companies try to offset the risk by charging higher placement and origination fees. Usually, interest rates charged by a _______ are the maximum legally allowed

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Private individuals

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Non-fiduciary lenders who offer an alternative source of financing. They participate in financing real estate by carrying back loans on their own property and by investing in security instruments (mortgages and deeds of trust).
Sellers are a major source of junior loans to buyers. Sellers may finance a portion of the purchase with a carryback loan. Sellers often require larger down payments than institutional lenders because of the higher risk normally associated with this type of loan.

Private investors who are looking for a higher rate of return than what is available in a bank certificate of deposit may buy and sell existing short-term junior loans through a mortgage company. Their main objectives are the safety of the loan and a high return on their investment

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Types of Lenders

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1) Fiduciary Lenders
-Commercial banks
-Thrifts
-Credit unions
-Life insurance companies
-Pension fund

2) Semi-Fiduciary Lenders
-Mortgage companies
-REITs

3) Non-Fiduciary Lenders
-Finance companies
-Private investors

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Third party originators (TPOs)

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Originate but do not underwrite or fund loans. TPOs complete loan packages and act as the mediator between borrowers and lenders. TPOs include mortgage brokers and loan correspondents

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Mortgage broker

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Originates loans with the intention of brokering them to lending institutions that have a wholesale loan department. Mortgage brokers are third party originators (TPOs) and not lenders. Mortgage brokers qualify borrowers, take applications, and send completed loan packages to the wholesale lender. The lender approves and underwrites loans and funds them at closing. Usually, mortgage brokers are not authorized to provide final loan approval and they do not disburse money. The loan is funded in the name of the lender and not the mortgage broker. The mortgage broker does not service the loan and has no other concern with it once it is funded.

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Loan correspondent

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Usually a third party originator who originates loans for a sponsor. However, the purchaser of the closed loan may make the underwriting decision in advance of closing. Alternatively, the purchaser may grant the authority to underwrite the loan according to its guidelines and allow the entire process to be undertaken by the correspondent who simply ships a funded loan. If the sponsor funds the loan, the process is called table funding

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Table funding

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The lender’s ability to provide loan funds on the same day the transaction is signed by all parties, which is usually the same day as the closing. In the course of table funding, the correspondent closes a mortgage loan with funds belonging to the acquiring lender. Upon closing, the loan is assigned to the lender who supplied the funds. However, some sponsors allow a correspondent to actually fund and close loans in the correspondent’s name, providing the loans meet the sponsor’s guidelines. The sponsor can force a correspondent to buy back a loan if it does not meet the sponsor’s guidelines. Therefore, loan correspondents have a risk that mortgage brokers do not have.

The sponsor retains the loan in its portfolio or packages and resells the loan in the secondary mortgage market as part of a pool. Many insurance companies are sponsors for loan correspondents

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Loan origination

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The lending process from application to closing

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Retail loan origination

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Refers to lenders (banks, thrifts, and mortgage bankers) that deal directly with the borrower and perform all of the steps necessary during the loan origination and funding process. This retail approach to loan origination is an outgrowth of early 20th century banks and savings and loans

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Origination fee or points

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Normally, a retail lender is paid a commission of 1% or more of the loan amount. This fee is payable upon funding of the loan, plus any negotiated settlement fees and premiums paid by the purchaser of the mortgage to the lender after funding

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Wholesale loan origination

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Sometimes called third party origination, is the process in which mortgage brokers and loan correspondents originate loans. The third party originator completes the loan application with the borrower; verifies application information such as employment, income, and bank account information; and packages the file for underwriting. When the wholesale lender gets the loan package, the underwriting and funding is completed before the lender pays any premium due to the TPO

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Why Wholesale Lending?

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Wholesale loan origination has pros and cons. The most important benefit to the wholesale lender is the large number of loans that may be purchased from TPOs. These loans may be acquired more economically than if the retail lender originated them. This is because the wholesale lender does not require a large staff to process the loans. Therefore, it can focus on other aspects of the transaction that fit its business model.

Another benefit to a wholesale lender is flexibility in the market. Money markets may change quickly and a wholesale lender can move its concentration to do business in other locations without as much concern about personnel or even a physical location. If a market declines rapidly, a wholesale lender can stop purchasing loans in one geographic area and buy loans in another location where the market is more profitable.

A lender who uses the wholesale approach can purchase more loans and have greater sources of revenue. After the loans are bought from correspondents or funded and closed for the mortgage brokers, they can be sold very quickly into the secondary mortgage market with the wholesale lender holding the servicing rights, or kept for interest earnings.

A loan is only as good as the originator makes it, and the issue of quality control is a major factor for a wholesale lender.

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Quality control

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Refers to the procedures used to check loan quality throughout the application and funding process. Loan wholesalers must rely on the integrity of the correspondents and brokers with which they do business. The procedures used to perform appraisals, verify important employment and credit information, and gather other critical information must be done according to the highest standards to avoid the serious problems that come when a borrower defaults on a loan