REAL ESTATE FINANCE Ninth Edition

1. REAL ESTATE FINANCE Ninth Edition John P. Wiedemer and J. Keith Baker

2. Chapter 4Other Primary Market Lenders

3. LEARNING OBJECTIVES • At the conclusion of this chapter, students will be able to: • Understand the unique relationship of the mortgage companies and mortgage brokers to the real estate finance industry. • Describe the purposes of a mortgage bank and how they differ from those of a mortgage broker. • Understand the licensing and registration requirements for those engaged in making residential mortgage loans. • Explain the basics of the various methods of funding mortgage-lending Activities. • Describe the principal source of income for mortgage lenders. • Understand the role of the various government loan programs for the direct financing of real estate. • Describe the other primary sources of real estate mortgage financing.

4. Introduction • This chapter examines mortgage companies which include both mortgage bankers and mortgage brokers. • Mortgage companies were a dominant source of residential mortgages from the 1980s to 2007, when they handled close to half of all loans. • One effect of the recent financial crisis has been the consolidation of the mortgage banking industry and the increasingly important role of commercial banks as residential mortgage originators. • At the end of 2009 commercial banks originated 51% of residential mortgage loans. • Agricultural real estate finance encompasses a smaller segment of the loan market and has seen extensive changes. • Another portion of the loan origination market involves individuals and others who participate in making mortgage loans.

5. Mortgage Companies • Mortgage companies without depositors were not a concern for the government. • Mortgage companies were granted no help after the Depression. • Mortgage companies then promoted FHA and VA loans, which had been widely rejected by regulated lenders. • Mortgage companies are still the main originators of FHA and VA loans. • Mortgage companies share the mortgage market with regulated lenders; each has a market share of about half of all loan originations. • Mortgage companies rely on commercial banks that grant them “warehouse” lines of credit. • Mortgage bankers lend money and mortgage brokers broker loans.

6. Mortgage Brokers • With the decline in the savings and loan industry residential mortgage brokers came to the forefront. • Knowledgeable individuals formerly trained in regulated institutions began working as mortgage brokers. • Residential mortgage loan brokers are now referred to by their primary licensing regulator, the National Mortgage Licensing System (NMLS), as “mortgage loan originators” (MLOs). • The NMLS was created to provide a uniform mortgage application; a nationwide repository of licensed mortgage professionals; and a minimum education, experience, and testing requirement Under the Secure and Fair Enforcement for Mortgage Licensing Act (SAFE). • The SAFE Act requires all residential mortgage loan officers who to have a unique identifier or registration number generated by the NMLS.

7. Mortgage Brokers • A mortgage broker specializes in serving as an intermediary between the customer/ borrower and the client/lender. • Brokers are capable of handling all arrangements for the processing of the loanbut normally do no funding and do not service the loan. • The broker earns a portion of the normal origination fee plus an application fee. • Large commercial loans are normally funded directly by the lending institution, such as an insurance company, and the monthly payments on debt service go directly to the lender.

8. Mortgage Bankers • The distinction between “bankers” and “brokers” has diminished. • Nevertheless, an essential difference between the two remains—the full-service facility offered by mortgage bankers. • Full service means: • (1) originating the mortgage loan • (2) funding the loan at closing • (3) servicing the loan as it is paid off • But even this distinction is blurring as brokers divide themselves into those who close loans in their own names and those who close in another lender’s name.

9. Qualifications of a Mortgage Lender • With the passage of the SAFE Act in 2008, the federal government signaled its intent to increase uniformity in the regulation and licensing of residential mortgage loan originators. • The SAFE Act eases regulatory burdens, enhances consumer protection, and reduces fraud by establishing the NMLS. • This new has had the greatest effect on the independent residential mortgage brokerage community. • Mortgage company qualifications are set mostly within the industry itself, although many states require mortgage company licensing. • Approval by either HUD/FHA or VA in itself is often accepted by conventional lenders as adequate qualification except for minimum capital requirements, which can be much higher for Fannie Mae and Freddie Mac.

10. Licensing of Mortgage Loan Officers • By 1996 all but eight states had some registration or licensing requirements for the mortgage industry. • State and federal officials determined that a uniform licensing method should be implemented, and Congress passed the SAFE Act. • The SAFE Act mandates minimum standards for mortgage loan originators, including the following five general requirements: • 1. A criminal history and credit background check • 2. Pre-licensure education • 3. Pre-licensure testing • 4. Continuing education • 5. Evidence of certain net worth and provide a bond or recovery fund

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12. Licensing of Mortgage Loan Officers • The requirements above apply to those residential loan originators who do not work for an institution that takes federally insured deposits. • The NMLS grants national licenses and unique identifier numbers to individuals whom it refers to as mortgage loan originators or MLOs. • Texas uses the term “Residential Mortgage Loan Originator” to describe its licensees.

13. Who Needs to Register With NMLS? • If your institution is federally chartered or insured by one of the following agencies and employs individuals required to be federally registered as mortgage loan originators, your institution must register with NMLS. • • Office of the Comptroller of the Currency • • Board of Governors of the Federal Reserve System • • Federal Deposit Insurance Corporation • • Office of Thrift Supervision • • Farm Credit Administration • • National Credit Union Administration

14. Mortgage Company Operations • The business organization common to most operates with three basic divisions: 1) administration, 2) loan servicing, and 3) loan acquisition. • The administrative group directs all operations and seeks out lending institutions and poolers of mortgages for mortgage-backed securities. • Loan servicing includes the record-keeping section that maintains borrowers’ accounts, holds insurance and tax deposits, collection of monthly payments, and notifications of delinquencies. • The loan acquisitiongroup consists of loan originators/officers who make the contacts with potential borrowers. Administrate – Service - Acquire

15. How a Mortgage Company Funds Loans • Mortgage companies do not hold deposit assets that can be loaned. • They must use different procedures to obtain funds for loans. • Mortgage bankers generally borrow money from a commercial banker on a warehouse line of credit to fund a loan at closing. • The loan is pledged as collateral and held, or “warehoused,” by the bank until it can be sold. • Other methods are used by mortgage companies dealing with the larger commercial loans. • These loans are more likely to be placed on a case by case basis with the most suitable lender available at the time.

16. Sale of Loans to Secondary-Market Investors • A procedure long used by mortgage companies is the purchase of a forward commitment in advance of making any loans. • This commitment is a promise by a lender to have certain funds available for qualifying loans submitted to that lender. • With a forward commitment the mortgage company assures a banker that loans pledged on a warehouse line of credit have a ready market. • A forward commitment often includes an agreement for the mortgage company to service the loans that are delivered to the loan purchaser. • The agreement between originator and purchaser is known as a sales and servicing contract. • Fannie and Freddie buy loans through the sale of forward commitments

17. Representative or Correspondent Basis • Insurance companies, pension funds, and other loan purchasers sometimes specialize in handling certain kinds of property loans, such as those for hotels or shopping centers. • Rather than deal with a variety of loan originators, these companies often work through selected representatives throughout the country. • These representatives (correspondents) are commercial loan companies that understand the special requirements of each loan. • If a customer is seeking a hotel loan the mortgage company will handle the contact with a secondary-market investor most interested. • The mortgage company serves as a loan broker, negotiating the loan for an investor. • The investor then funds the loan at closing and handles the servicing.

18. Selling Mortgage-Backed Securities • These sales involve converting loans into mortgage-backed securities. • Most loan originators sell their loans to large loan poolers such as an investment bank or Fannie Mae. • One method is to place a multimillion-dollar block of mortgage loans in the care of a trustee, such as an authorized bank. • Then the mortgage company issues a series of certificates backed by the block of loans, which is the collateral for the securities. • The certificates are sold to investors and the money received from these certificates is used to reimburse the mortgage company. • This procedure is often identified as securitizing mortgages.

19. Mortgage Company Income • Profit margins are narrow in handling mortgage loans. • Mortgage companies make little, if any, money from the discount, since that amount passes to the loan purchaser as part of the cost of money. • What the mortgage company is really doing is buying a piece of paper—the mortgage note—when it funds the loan at closing. • Then the note is sold to a secondary-market purchaser. • The difference between what is funded at closing and what the mortgage company sells the note for is the amount it earns. • Some lenders will charge a higher interest rate than market rates to add additional profits called “yield spread premium.” • The dependable income for loan originators comes from various fees: application fees, origination fees, yield spread premium and servicing fees.

20. Application Fee • Loan originators normally charge a nonrefundable application fee at the time an application is taken. • The fee covers certain costs incurred in screening an application. • The fee is not regulated (except for HUD/FHA and VA) and is charged by almost all originators, not just mortgage companies. • For residential loans, the fee is in the $150 to $450 range, while fees for commercial loans are often based on the size of the loan.

21. Origination Fee • A separate charge of one to two percent of the loan amount. • It is a charge incurred for assembling a loan package and making the decision to accept or reject the loan. • The charge is for services rendered but is tax deductible for the borrower if certain rules are followed. • It is a separate charge from the discount, which is also tax deductible, but the two are not always differentiated when loan costs are quoted. • Mortgage personnel should disclose the distinction to borrowers. • Mortgage companies usually split the fee, with half going to the loan representative who contacts the borrower and takes the loan app. • This fee is considered the “commission” earned by the representative and is not paid if the loan fails to close.

22. Servicing Fee • The charge made for handling the loan after it has been funded. • Services involve collecting and accounting for payments, handling the escrow account, and following up on delinquent accounts. • The fee amounts to 0.25 to 0.50 percent of the loan balance. • Servicing large blocks of loans can be a lucrative business and specialized companies have developed to perform just this function. • Sometimes a loan originator accumulates several billion dollars in loans to service and will sell a portion of the block to acquire cash.

23. Loan Servicing Disclosure Notice • The servicing function may be transferred at any time. • Scam artists using unauthorized, or stolen, lists of borrowers can direct payments to a post office box, skim the collections and disappear. • Originators now provide borrowers with a servicing disclosure notice. • The notice must include an explanation of two points: • (1) the possibility that loan servicing may be transferred • (2) the rights of a borrower should such a transfer occur • Must provide a borrower with an estimate, expressed as a percentage, of the possibility of transfer. • Notice must be sent not less than 15 days prior to any transfer, and the new servicing company must confirm the change within 15 days after. • A toll-free must be provided for the borrower to contact the servicing company.

24. Automated Loan Underwriting • An explosive growth in mortgage originations has led to the use of computer programs using artificial intelligence in the analysis, and even the final approval, of residential loans. • HUD has encouraged the greater use of computerized loan underwriting, as it can lower costs and give more unbiased analysis. • This method has brought an increase in the use of credit scoring and offers ways to expedite appraisals. • Because of the many advances in technology, it is now possible for an individual to negotiate a mortgage loan on the Internet.

25. Government Loan Programs • There are some programs that handle direct loans to borrowers; that is, the agencies work in the primary market. • Many such programs require that the loan applicant first attempt to borrow the money from private sources. • Direct mortgage loan programs offered by the federal government are almost all farm related. • State- and municipal-sponsored loan programs are mostly housing related.

26. Farm Credit System • A borrower-owned network of farm lending banks under the supervision of the Farm Credit Administration (FCA). • The FCS is composed of four regional farm credit districts owned by over a million American farmers their cooperatives. • The system makes long-term mortgage loans and shortterm crop loans through different organizations. • Most of the financing is handled through the sale of six- to nine-month securities, and some with two- to five-year coupon notes. • Generally, loans are limited to 85 percent of the appraised value of the property, with a term of not less than five years and not more than 40. • Interest rates for most loans apply a variable-rate plan based on the FCS cost of funds.

27. United States Department of Agriculture - Rural Development • The Rural Development Housing & Community Facilities Programs (RHS) holds another $50 billion of the debt owed by farmers. • Provides loans for farms, homes, parks, camping facilities, hunting preserves, access roads, waste disposal systems, and disaster areas. • Also provides loan guarantees to help local lenders extend credit needed for the growth and preservation of jobs. • It has expanded its traditional lending base to include towns of up to 50,000 but gives priority to towns of less than 25,000.

28. Home Ownership Loans • The Rural Development Service’s home loan program is limited to rural areas and to low- and moderate-income families unable to qualify for home financing in the private market. • Loans can be made up to 100% of the appraised value of a house for a maximum term of 33 years (38 years for those with incomes below 60% of AMI and who cannot afford 33-year terms). • Eligibility is limited to those with very low income, defined as below 50% of the area median income (AMI); low income is between 50 and 80% of AMI; moderate income is 80 to 100% of AMI. • One can visit www.rurdev.usda.gov/HSF-Direct_Income_Limits.htmland click the Metropolitan Statistical Area, or “MSA,” nearest one’s location to learn current income limits listed by family size.

29. Other Primary Market Lenders • The opening of the secondary market and the wide acceptance of mortgage-backed securities have encouraged many newcomers. • The next section discusses the major players in this field, who are not subject to banking regulations.

30. Other Primary Market Lenders Nonbank Lenders These include such major operators as ING Group, Ally Financial, General Motors Acceptance Corporation, GM Financial (formerly AmeriCredit), and the retail finance division of GE Capital. Investment Bankers As many investment bankers expand into handling various money market accounts, retirement funds, and even checking accounts, some have entered mortgage loan origination. Edward D. Jones, Charles Schwab Company, Merrill Lynch, and Raymond James & Associates are all examples of this kind of lender. Finance Companies Many small loan companies such as HSBC Household International that formerly made mostly unsecured personal loans have expanded into mortgage lending as a better method of securing their loans.

31. Other Primary Market Lenders Home Builders KB Home, Pulte Homes, D. R. Horton and others, have entered the market through subsidiaries that process loans and sell into mortgage pools. Real Estate Brokerage Firms Companies that have developed national real estate brokerage operations through direct acquisitions or franchise networks have entered the loan origination business. Such companies as Century 21 and Prudential are now able to offer mortgage loan services in their own offices. Internet The newest method of negotiating a mortgage loan is through contacting a mortgage loan site on the Internet. An individual who may have a tarnished credit record and wants to remain anonymous, a person living in a rural area who wants to avoid traveling a long distance, or maybe even someone with an excellent credit record who feels more comfortable with an impersonal interview are all lured to the Internet.

32. Other Primary Market Lenders Computerized Loan Origination (CLO) Today CLO is one method used by real estate brokers to assist buyers in negotiating a loan to purchase a property. Current HUD rules allow a person or company who initiates the loan and assists in helping a borrower furnish the necessary information to earn a fee that is reasonably commensurate with the work performed. Pension Funds During the past decade, pension funds have become large investors in mortgage loans. By far the most common method is through the purchase of mortgage- backed securities. In this way investors avoid the management problems associated with individual mortgage loans and are able to treat such investments as just another kind of security. However, a few pension groups, particularly those operated by state agencies and by labor unions, offer home loan programs as primary lenders.

33. Other Primary Market Lenders • Real Estate Investment Trusts (REITs) • Must be structured as a corporation, trust, or association. • Must be managed by a board of director or trustees. • Must have transferable shares or certificates of interest. • Must be formed as an entity that is taxable as a corporation. • Financial institutions and insurance companies cannot be a REIT. • Must have joint ownership with at least 100 persons owning the stock. • Must not have more than 50% of shares held by five or fewer individuals. • 75% of total assets in real estate or in real estate–backed assets. • At least 75% of gross income must be from rents or mortgage interest. • Must pay shareholders annual dividends at least 90% of taxable income. • No more than 25% of assets may consist of stock in taxable subsidiaries

34. Other Primary Market Lenders Individuals Many individuals make mortgage loans, sometimes with reluctance. Title Companies May act as primary sources in lending their own funds. Universities, Colleges, and Hospitals Many endowments take the form of land and other real property, and these may require more expertise in the mortgage loan field. State Housing Agencies States have universally adopted down payment assistance programs. Foundations Established primarily by corporations or wealthy families as a means of continuing charitable activities. Fraternal, Benevolent, and Religious Associations Some of these organizations limit lending to their own members and will provide low-cost loans to qualified members.

35. Questions for Discussion 1. Distinguish between the operations of a mortgage banker and a mortgage broker. What are the five major minimum standards that an independent mortgage broker or loan office must pass to be licensed with the NMLS? 2. What qualifications are necessary to become a mortgage banker? Are there any special requirements for mortgage lenders in your state? 3. What is meant by loan servicing? 4. Identify the principal sources of mortgage company income. 5. How does the Farm Credit System structure the various agencies that handle oversight of the farm mortgage lending function? 6. Describe qualification for the Rural Development Service’s home loan program. 7. Explain the origin and purpose of Real Estate Investment Trusts. 8. Name three primary market lenders that are not subject to banking regulations. 9. Describe a warehouse line of credit and who may use it. 10. Are there any good sources of mortgage money available in your locality outside of mortgage companies and regulated lending institutions?