The mortgage market and how it worksThe mortgage market can seem complicated. Fact is, it is not as complicated as it is ever-changing. By understanding the market, you will get a better idea about mortgage programs offered by certain lenders.
The Mortgage Market and How It Works
The mortgage market can seem complicated to the uninitiated. The fact is that it is not as complicated as it is ever-changing. Most people have no idea how the market works. By understanding this, you will get a better idea about mortgage programs that are offered by certain lenders. Armed with this new information, you can make an informed decision in your quest for the perfect mortgage.
Who are the lenders?
The first step in understanding the mortgage market is to understand who is actually loaning you the money. An important distinction that you must make is between institutional lenders and private lenders. Institutional lenders are:
- Commercial banks
- Savings and loans
- Credit unions
- Mortgage banking companies
- Pension funds
- Insurance companies
These lenders make loans based on income and credit of the borrower. They are also federally insured and follow standard lending guidelines.
Private lenders, on the other hand, are either individuals or small companies. They are not regulated by the government, so their lending guidelines may be more flexible.
Another thing you should know about lenders is the difference between mortgage brokers and mortgage bankers. Many people see the word “mortgage company” and think they are banks that lend their own money. This is not always the case.
If you are dealing with a mortgage banker then, yes, they are a direct lender. This means they lend you their own money and make money from the interest they charge.
Mortgage brokers, on the other hand, are middlemen that are responsible for putting lenders and borrowers together. The advantage to a mortgage broker is that they might have access to many different lenders that do not deal directly with the public.
The lender often depends on the type of loan
So, now you know who the lenders are and how the market works. The last thing to understand about the mortgage market is about the loan itself. There are 2 types of conventional loans:
Conforming loans. These loans adhere to strict Fannie Mae/Freddie Mac underwriting guidelines, are low risk to the lender, and offer the best interest rates.
Non-conforming loans. These loans’ guidelines are set by individual lenders.
Conforming loans have 3 basic requirements:
- Borrower must have a low debt/equity ratio. Generally, the regular monthly PITI payment should be no more than 25-28% of gross monthly income.
- Good credit. Generally, this is a FICO score of more than 680+.
- Money to close the loan. This includes a down payment (and proof that it is from your funds) and cash reserves for a few months.
- A non-conforming loan does not require these guidelines. They have laxer guidelines and can be secured with less-than-perfect credit. Individual lenders have different programs for these kinds of loans. Many institutional lenders do not offer non-conforming loans.
The primary and secondary mortgage market
Now that you know who the lenders are and the types of loans, you should understand how the market itself works. There is a primary and secondary market for mortgages. The primary lender is the one who deals directly with the public. They are the ones that originate the mortgage loans. But they do not lend the money themselves. A primary mortgage lender makes money from the loan processing fees rather than the interest paid on the loan.
These primary lenders often lend money to customers and then sell a large number of the notes to investors in the secondary market. This replenishes their cash reserves. The lenders on the secondary market are the ones who make money from the interest.
So the institution that initially lends you the money more than likely will sell your mortgage note to another company on the secondary market. The largest buyers on the secondary market are:
- Federal National Mortgage Association (FNMA or “Fannie Mae”)
- Government National Mortgage Association (GNMA or “Ginnie Mae”)
- Federal Home Loan Mortgage Corporation (FHLMC or “Freddie Mac”)
Since these government agencies are the biggest buyers on the secondary market, institutional lenders who want to sell your note on the secondary market to these agencies need to conform to their underwriting policies. That way, the government agencies are more likely to buy the note on the secondary market.
Other private banks or financial institutions also buy mortgage notes. Over the period of your mortgage, the note may be sold many times before it is finally paid off or refinanced.