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Chapter 2. The Mortgage Industry

┠What is the mortgage industry?

┠Why would a primary lender sell a loan?

┠Will I know if my loan is sold?

┠Who buys these loans?

┠What is a conforming loan?

┠What does the secondary mortgage market mean to me?

What is the mortgage industry?

There is a long list of the types of lenders that make loans using a mortgage for security. They include government agencies, lending institutions (such as banks and mortgage bankers), credit unions, finance companies, mortgage brokers that arrange loans, insurance companies, and even individuals.

There are two types of lenders. The first type of lender is the primary lender, which is the type you will deal with. This may be a local bank or other financial institution that meets with you and originates your loan. After your transaction is completed, your primary lender can either keep the loan or sell it on the secondary market. If your lender keeps the loan, it is called a portfolio loan.

The second type of lender is one that buys loans made by primary or retail lenders, and does not deal directly with the public. Entities that buy existing loans in the secondary mortgage market may be pension funds, for example, or even primary lenders that have money but cannot originate enough loans. The largest buyers are government agencies or quasigovernment agencies — private companies originally created by Congress.

Why would a primary lender sell a loan?

Primary lenders make money on the fees you pay when the loan is made and on the interest they collect over the life of your loan. However, if you have a thirty-year loan, it will take the primary lender thirty years to make all its money. This ties up money the lender has available to make loans into one property and borrower for the life of the loan. If the primary lender sells the loan, it makes an immediate profit on its money — albeit less than if it had kept the loan for the full thirty years — and gives it money to continue making other loans.

A primary lender can also make money on servicing the loan it sells. This means that the primary lender still sends out your monthly statement and collects the money, but it then forwards it to the company that bought your loan. In other words, the primary lender acts as an administrator of sorts for a loan it sells, and then charges a fee for performing that service.

Will I know if my loan is sold?

You may or may not ever know whether your loan has been sold. If your primary lender is still servicing the loan, you will not know that it is actually being held by another company. If the buyer of your loan is servicing it or uses a different servicing agent, you will get a notice that your mortgage has been sold, and you should make future payments to the buyer or buyer's servicing agent.

Regardless of whether or not your loan is sold, the terms of your loan will not change, and you will not have to pay more money to the new company just because your loan has changed hands. It is not something that you need to worry about. People often think that their payments are going to increase or their interest rate will rise if their loan is sold, but that is simply not true.

Who buys these loans?

The two organizations that buy the most loans are the Federal National Mortgage Association, known as Fannie Mae, and the Federal Home Loan Mortgage Corporation, better known as Freddie Mac. They are private companies that began as government agencies.

The following is how Freddie Mac describes itself.

Freddie Mac is a stockholder-owned corporation chartered by Congress in 1970 to keep money flowing to mortgage lenders in support of homeownership and rental housing. Freddie Macpurchases single-family and multifamily residential mortgages and mortgage-related securities, which it finances primarily by issuing mortgage pass through securities and debt instruments in the capital markets. By doing so, we ultimately help homeowners and renters get lower housing costs and better access to home financing.

This means that Freddie Mac gets its money by selling instruments that are types of bonds on Wall Street. The mortgage rates are the rate of return on the mortgage-backed securities, and the mortgages secure the debt. You can buy a mortgage-backed security, creating a big circle that keeps the money flowing.

From the Expert

Charges for administrative or processing fees, commonly called garbage fees, can vary depending on the lender. Take these charges into account when evaluating lenders.

The government agency Government National Mortgage Association, called Ginnie Mae, is also involved in the secondary market. Ginnie Mae does not buy loans or issue mortgage-backed securities. Its role is to guarantee payments to investors on their mortgage-backed securities, reducing the risks associated with these investments. Less risk generally means more people are willing to invest — keeping more money in the system so more loans can be made.

What is a conforming loan?

In order to make the system run smoothly, the secondary market participants set out guidelines for primary lenders. If the primary lender conforms (follows the guidelines in making the loan), it knows that the loan can be sold. Since a large percentage of primary lenders make loans with the intention of selling them, most lenders only make loans that conform to the requirements of the secondary market.

The sale of your loan does not affect your interest rate. The secondary lender buys loans based on prevailing interest rates. If a retailer wants to sell the loan, it knows the interest rate that it must charge to sell at face value. If a higher rate is charged, the loan may be sold at a premium — an amount higher than face value. If lower than the prevailing rate is charged, the loan will be sold at a discount, meaning less than face value.

What does the secondary market mean to me?

Different secondary lenders have different guidelines that must be met before they will buy a loan. For example, Fannie Mae and Freddie Mac have a limit on the loan amount they can purchase for each loan. The limit changes as real estate prices change, and it is different in different regions of the country. Also, many of the participants in the secondary market only buy certain types of loans. To meet these guidelines, many originating lenders specialize in a particular type of mortgage. This helps the primary lender know who will be buying the loans it makes and if it will have a problem selling them on the secondary market.

Armed with that knowledge, a smart borrower shops around for a lender that specializes in the type of loan he or she wants. That lender will be more knowledgeable and more efficient in obtaining that type of loan. Understanding which loan is best for you is the focus of the rest of the book.

However, many lenders will simply try to sell you the loan they know best because it is easier for them. If it is not the loan that is best for you, do not stay with that lender.

There is a secondary market for all loans — even those made by individuals selling their homes and providing the financing to the buyer themselves. It consists of individuals and companies that specialize in buying these mortgages. Without the larger players, this is a much smaller market. Since these mortgages are usually sold at a substantial discount (much less than their face value), it may be more difficult to find a lender providing loans that can be sold in this market. The buyers in this secondary market have their own guidelines, which may be very different from those of the large institutions like Fannie Mae and Freddie Mac.

From the Expert

A lender can make a mortgage loan without following anyone's guidelines, as long as the loan does not violate the law. Any lender planning to keep the loan for its own portfolio follows its own guidelines.

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