Big banks used to do a thriving wholesale mortgage business.  Working through mortgage brokers they’d issue mortgages direct to millions of homeowners with the broker taking the marketing risk but getting points and risk-yield premiums as his or her upside. Like an insurance agent the broker was acting purely as a reseller for the bank.  Well it doesn’t work that way anymore.  NONE of the big banks are still doing such wholesale operations, though you can still find smaller banks and regional lenders in the field.

Wholesale mortgages like this are a heck of a business for banks, making them more profit, on average, than selling the same mortgage through a local bank branch.  This is simply because of overhead and marketing expenses.  Banks pay none of that for brokers yet all of it for their own salespeople.

Why, then, have the big banks abandoned the wholesale business?  That’s a good question.  They imply it’s because the want to reduce risk but that’s not true.  Wells Fargo, for example, is the last major banks to drop their wholesale product.  But while Wells dropped wholesale, they are still running their correspondent mortgage operation, which makes little sense at all if the goal was to reduce risk by dropping the brokers.

Correspondent lenders are companies that have their own lines of credit.  They wholesale to the big banks in the sense that they hand over bundles of a dozen or so loans at a time to outfits like Wells, but the initial funding is done from that line of credit, making the correspondent a mortgage banker, not a mortgage broker.  A key difference from the perspective of the big bank is that the correspondent lender actually underwrites the loan.  Any contingent terms are set by the correspondent, not the big bank, and in fact the big bank never even sees a credit report on the borrower.

Shouldn’t that mean the risk is higher for this type of operation?

Of course it does, which means that using risk aversion as an excuse for dropping traditional wholesale lending is a lie.

The real reason Wells and the others dropped wholesale is because they can.  Mortgage brokers don’t require severance payments and don’t have COBRA health insurance.  Banks don’t care about brokers and can kill them with abandon knowing that they can reestablish the business overnight if conditions change.

And that’s exactly  what they’ll do, which makes this abandonment of the wholesale channel more or less meaningless. Unless of course you are a mortgage broker.

15 Comments » Posted by APIyuIRrClENtBtCk / Mortgage Lore

Given that this current financial crisis supposedly started with problem mortgages, how do you tell if you have one of those?  I have this gut feeling that there are more people out there who have sub-prime and alt-a mortgages and don’t even know it.  After all, I’ve never heard a mortgage broker try to sell something with a name like sub-prime or alt-a, but I know that at least one of my mortgages (I have two — on two different houses) definitely IS from one of the despised categories.

So what does it even mean to have a so-called “sub-prime” mortgage?  Here is the technical definition of sub-prime according to Wikipedia:

“Subprime borrowers have a heightened perceived risk of default, such as those who have a history of loan delinquency or default, those with a recorded bankruptcy, or those with limited debt experience. Although there is no standardized definition, in the US subprime loans are usually classified as those where the borrower has a credit score below a particular level, e.g. a FICO score below 660. Subprime lending encompasses a variety of credit types, including mortgages, auto loans, and credit cards.  Subprime could also refer to a security for which a return above the “prime” rate is received, also known as C-paper. In the United States, mortgage lending specifically, the term “subprime” can be applied to “non conforming” loans, those that do not meet Fannie Mae or Freddie Mac guidelines, generally due to one of an array of factors including the size of the loan, income to mortgage payment ratio or the quality of the documentation provided with the loan.”

So if that’s the definition of sub-prime, how does that vary from “alt-a?”

Again, from Wikipedia:

“An Alt-A mortgage, short for Alternative A-paper, is a type of U.S. mortgage that, for various reasons, is considered riskier than A-paper, or “prime”, and less risky than “subprime,” the riskiest category. Alt-A interest rates, which are determined by credit risk, therefore tend to be between those of prime and subprime home loans. Within the U.S. mortgage industry, different mortgage products are generally defined by how they differ from the types of “conforming” or “agency” mortgages, ones guaranteed by the Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac.

“There are numerous factors that might cause a mortgage not to qualify under the GSEs’ lending guidelines even though the borrower’s creditworthiness is generally strong. A few of the more important factors are:

• Reduced borrower income and asset documentation (for example, “stated income”, “stated assets”, “no income verification”)
• Borrower debt-to-income ratios above what Fannie or Freddie will allow for the borrower credit, assets and type of property being financed
• Credit history with too many problems to qualify for an “agency” loan, but not so many as to require a subprime loan (for example, low scores or serious delinquencies, but no recent charge-offs or bankruptcy)
• Loan to value ratios (percentage of the property price being borrowed) above agency limits for the property, occupancy or borrower characteristics involved

“In this way, Alt-A loans are “alternatives” to the gold standard of conforming, GSE-backed mortgages.”

Okay, so an alt-a is a type of sub-prime mortgage but generally not as bad as a pure sub-prime, whatever that is.  I think the key distinction in these things is the FICO or credit score.  Alt-A borrowers tend to have scores above 660.

So do you have a sub-prime mortgage?  If you have a non-conforming loan like a jumbo you are some form of sub-prime no matter how high your credit score of how low your loan-to value ratio.  If you have a low-doc or a no-doc loan it is non-conforming and also sub-prime even if you aren’t.  You have a sub-prime loan if your mortgage is interest-only or some funky variety like an Option ARM.

As a result there are probably a lot more sub-prime mortgages and mortgage holders than you’d expect.  I’m one because I have a jumbo.  Are you?

4 Comments » Posted by cringely / Mortgage Lore

       The Federal Reserve has a meeting, lowers the Federal Funds Rate, which leads banks to lower their prime lending rate which results in mortgage rates dropping, too, right?  Usually wrong.  It doesn’t work this way every time, but USUALLY when the prime rate drops mortgage rates spike up a bit.

       Why?

       To answer that I turned to my friend Jack who has been in the mortgage business since he was 17 years old.  Imagine getting a mortgage from a kid still in high school, yet that’s exactly what happened with Jack, who grew up in the family mortgage business.

      ”It has to do with competition for money,” explained Jack.  ”When the prime rate goes down it stimulates demand for business loans.  Business loans are funded from the same dollar pool that funds mortgages.  So this greater demand for business loans means there is effectively less money available to fund mortgages, so mortgage interest rates trend up as a result.”

       I’m sure Jack is right but it sounds like a scam to me.

No Comments » Posted by cringely / Mortgage Lore