The Mortgage Industry PDF

4 The Mortgage Industry Learning Objectives After completing this lesson, students should be able to... Explain the basic steps in the mortgage process Distinguish between different types of loan originators and the ways they help bo...

4 The Mortgage Industry Learning Objectives After completing this lesson, students should be able to... Explain the basic steps in the mortgage process Distinguish between different types of loan originators and the ways they help borrowers get funds Describe government regulations affecting loan originators at both the national and state level List the different types of mortgage lenders and the ways their businesses have changed over time Discuss important historical events in the mortgage industry, including the Depression and the savings and loan crisis, and the government’s response to these events Summarize the factors leading up to the mortgage and financial crisis, and the impact it may have on the mortgage industry Suggested Lesson Plan 1. Give students Exercise 4.1 to review the previous chapter, “The Primary and Secondary Markets.” 2. Provide a brief overview of Chapter 4, “The Mortgage Industry,” and review the learning objectives for the chapter. © 2018 Rockwell Publishing  Financing Residential Real Estate Instructor Materials 3. Present lesson content: Description of the Mortgage Industry – Basic steps in the mortgage process – Loan origination – Types of loan originators – Government regulation Mortgage Lenders – Depository institutions – Mortgage companies – Alternative sources of funding EXERCISE 4.2 Types of mortgage lenders Government Intervention in Mortgage Lending – The Depression – Savings and loan crisis – Mortgage and financial crisis – Government bailouts and oversight EXERCISE 4.3 Government intervention in mortgage lending 4. End lesson with Chapter 4 Quiz. Chapter 4 Outline: The Mortgage Industry I. Basic Steps in Mortgage Process A. The residential mortgage process involves a: 1. home buyer 2. loan originator (who arranges the loan) 3. mortgage lender (who funds the loan) 4. loan servicer (who collects and processes payments) B. The loan originator, lender, and servicer may not all be part of the same entity C. Often someone other than the lender services the loan II. Loan Origination A. Retail lenders 1. Retail lenders deal with borrowers directly; the borrower deals with the lender’s loan officers or loan originators 2  Chapter 4: The Mortgage Industry B. Wholesale lenders 1. With a wholesale lender, the borrower applies for a loan through an intermedi- ary—an independent broker or a loan correspondent 2. Most wholesale lenders are large, financial entities with national scope C. Types of loan originators 1. Loan officers: loan officers work for a retail lender; they help borrowers complete loan applications and supporting materials and pass the information on to the lender’s underwriting department for approval 2. Mortgage brokers: most mortgage brokers are independent contractors who work with various lenders; they act as an intermediary, bringing borrowers and lenders together, in exchange for a commission 3. Mortgage brokers don’t usually provide funds for loans; however, they may participate in “table funded” loans, in which the broker names herself as the origi- nating lender, but the loan proceeds are actually brought to the table at closing by the true lender D. Government regulation of loan originators 1. In 2008, Congress passed the Secure and Fair Enforcement for Mortgage Licens- ing Act (also called the SAFE Act); this law established a national system for the licensing and oversight of loan originators and brokers 2. All residential mortgage loan originators must be state-licensed or federally reg- istered 3. Real estate agents who receive commissions for helping arrange loans must also be licensed or registered III. Types of Mortgage Lenders A. The four main types of residential lenders are commercial banks, thrift institutions, credit unions, and mortgage companies 1. Banks, thrift institutions, and credit unions are depository institutions 2. Mortgage companies are not depository institutions (they don’t hold deposits) B. Commercial banks 1. Commercial banks were originally oriented toward loans for business ventures and construction; residential mortgages were a small part of their business 2. Regulatory changes made residential lending more attractive to commercial banks 3. Commercial banks are chartered by the federal or state government 4. Commercial banks are different from investment banks, which focus on securities and corporate finance, and do not accept deposits or make loans C. Thrift institutions 1. Savings banks were traditionally oriented toward small depositors, offering sav- ings accounts and making mortgage and consumer loans; today, savings banks usually offer the same services as commercial banks 3  Financing Residential Real Estate Instructor Materials 2. Savings and loan associations were originally created to finance home construction for members, and later began issuing loans to nonmembers and taking deposits from small depositors; deregulation in the 1970s allowed S&Ls to become more like banks D. Credit unions 1. Credit unions are nonprofit cooperatives that serve members of a particular group, such as a labor union or employees of a large company 2. Credit unions initially specialized in small, unsecured loans; they later expanded their scope to include home equity and residential purchase loans E. Mortgage companies 1. Mortgage companies, also known as mortgage bankers, are not depository institu- tions and focus exclusively on making mortgage loans 2. Mortgage companies may borrow money from a wholesale lender (with a line of credit), use it to originate mortgages, and then sell the mortgages to investors 3. Mortgage companies may also act as loan correspondents, originating loans on an investor’s behalf 4. Funding usually comes from national-scale investors, such as life insurance com- panies and pension funds, which don’t have the infrastructure to deal directly with consumers 5. A mortgage banker makes loans, while a mortgage broker is an intermediary who brings a borrower and a lender together for a commission; some mortgage com- panies do both F. Alternative sources of financing 1. Real estate investment trusts and real estate limited partnerships are additional sources of financing capital, but generally provide funds to builders and not to individual home buyers 2. Many home buyers receive financing from sellers, through primary or secondary financing 3. Seller financing is more popular when institutional loans are expensive or diffi- cult to obtain EXERCISE 4.2 Types of mortgage lenders IV. Government Intervention in Mortgage Lending A. The Depression 1. The Depression caused a wave of defaults and foreclosures; the government en- acted a number of reforms during the Depression to fix the mortgage industry, including creation of the Federal Housing Administration 2. The FHA provided insurance that protected lenders against default, so that lenders were more confident about issuing long-term (20- or 30-year) fully-amortized loans 4  Chapter 4: The Mortgage Industry B. The savings and loan crisis 1. Savings and loans dominated the residential lending market in post-World War II years 2. Deregulation in the early 1980s allowed S&Ls to engage in new investments, many of which were risky and didn’t pay off, causing many S&Ls to fail 3. Congress reformed the S&L industry through the Financial Institutions Reform, Re- covery, and Enforcement Act (FIRREA), but fewer S&Ls remained, and mortgage companies (and then banks) wound up with a much larger share of the residential lending market C. The mortgage market and 2007 financial crisis 1. An artificial surge in housing prices peaked around 2006 2. Various factors contributed to the financial crisis, including government policies encouraging homeownership, easy access to financing, and unrealistic expecta- tions 3. Lenders fueled the situation by lowering their underwriting standards—for ex- ample “no doc” loans requiring no credible proof of income or ability to repay 4. Lenders also offered “nontraditional” and high-risk products, such as low- or no-downpayment loans, low entry rates, and negative amortization loans; many borrowers mistakenly assumed that rising house prices would make it possible for them to get out of these loans through a future sale or refinance 5. Banks and other institutions bought and sold “securitized” investments that in- cluded mortgages that were at high risk of foreclosure and default D. Government bailouts and oversight 1. In 2008, the government reacted to the housing collapse (and growing foreclosure rates) by attempting to bolster the floundering mortgage market with the passage of the Housing and Economic Recovery Act (HERA) 2. About this time, the government also placed Fannie Mae and Freddie Mac into conservatorship, hoping to shore up investor confidence 3. In addition, Congress passed a large bailout bill called the Troubled Asset Relief Program (TARP), which authorized spending up to $700 billion to buy “troubled loans” (at high risk of default) that were causing significant financial problems for many of the country’s largest financial institutions 4. In 2010, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which made sweeping changes to the government’s financial regulatory scheme EXERCISE 4.3 Government intervention in mortgage lending 5  Financing Residential Real Estate Instructor Materials Exercises EXERCISE 4.1 Review exercise To review Chapter 3, “The Primary and Secondary Markets,” have students match each of the following terms to one of the descriptions below. Real estate cycles Primary market Disintermediation Government-sponsored enterprise Securitizing ______ 1._When a large number of mortgage loans are pooled as collateral. ______ 2._Withdrawal of funds from depository institutions in favor of investments that yield higher returns. ______ 3._A secondary market entity chartered by Congress and supervised by FHFA ______ 4._The market where buyers apply for loans and lenders originate them. ______ 5._Fluctuations in the local primary market that can disrupt the interaction between financial institutions and home buyers. Answers: 1. SECURITIZING. To create mortgage-backed securities, the secondary market enti- ties pool a large number of mortgages together and pledge them as collateral for the securities. 2. DISINTERMEDIATION. Competition with other investments can reduce the amount of funds local financial institutions have available for mortgage lending. 3. GOVERNMENT-SPONSORED ENTERPRISE. Fannie Mae and Freddie Mac are both government-sponsored enterprises, part of the secondary mortgage market. 4. PRIMARY MARKET. The primary market is the local real estate market where home buyers apply for loans and lenders originate loans. 5. REAL ESTATE CYCLES. Local real estate markets go through slumps that create problems for local financial institutions and potential home buyers. 6  Chapter 4: The Mortgage Industry EXERCISE 4.2 Types of mortgage lenders Match each of the following terms to one of the descriptions below: Credit union Thrift institutions Seller financing Mortgage company Commercial bank ______ 1._Institutions that initially offered services to small depositors, but later expanded their range of services when regulations changed. ______ 2._A depository institution that serves businesses and merchants. ______ 3._A non-regulated source of financing when other mortgage loans are expensive or difficult to obtain. ______ 4._Since it isn’t a depository institution, this type of lender must raise capital from other sources. ______ 5._A nonprofit cooperative created to serve members of a particular group. Answers: 1. THRIFT INSTITUTIONS. Savings banks and savings and loan associations began by offering services to small depositors and members, but today they provide a full range of services. 2. COMMERCIAL BANK. Commercial banks supply capital for business ventures, but residential mortgages have also become a significant part of their business. 3. SELLER FINANCING. Sellers can provide an alternative source of mortgage financ- ing for home buyers, through primary or secondary financing. 4. MORTGAGE COMPANY. Mortgage companies typically act on behalf of other investors or immediately sell their loans on the secondary market. 5. CREDIT UNION. Because they are nonprofit and are exempt from certain taxes, credit unions can often give their members better-than-market interest rates. 7  Financing Residential Real Estate Instructor Materials EXERCISE 4.3 Government intervention in mortgage lending Match one of the following mortgage industry events to the government interventions listed below (answers may be used more than once): The Depression The savings and loan crisis The mortgage and financial crisis ______1._ Deregulation and passage of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) ______2._ Passage of the Troubled Asset Relief Program to help financial institutions owning “toxic assets” ______3._ Creation of the Federal Housing Administration and the Federal National Mortgage Association (Fannie Mae) ______4._ Placement of Fannie Mae and Freddie Mac into conservatorship Answers: 1. THE SAVINGS AND LOAN CRISIS. The Financial Institutions Reform, Recovery and Enforcement Act (or FIRREA) was a federal law passed in 1989 in response to the savings and loan crisis, to reform the thrift industry and provide greater protections in the future. 2. THE MORTGAGE AND FINANCIAL CRISIS. The Troubled Asset Relief Program (or TARP) was passed in 2008 to respond to the financial problems many large financial institutions were experiencing as a result of the mortgage and foreclosure crisis. 3. THE DEPRESSION. The government created the FHA and Fannie Mae to deal with the wave of defaults and foreclosures during the Depression. The FHA provided insurance that protected lenders against default, so lenders would be more willing to issue longer-term (e.g., 30 year) loans. 4. THE MORTGAGE AND FINANCIAL CRISIS. In the summer of 2008 the federal government placed Fannie Mae and Freddie Mac into conservatorship, and created a new regulatory agency that would provide more stability and direct government oversight. 8  Chapter 4: The Mortgage Industry Chapter 4 Quiz 1. In 2008, the federal government placed which 6. The introduction of the Federal Housing Ad- entities into conservatorship? ministration and the mortgage insurance that it A. Ginnie Mae provided led to increased use of: B. Fannie Mae A. adjustable-rate mortgages C. Freddie Mac B. interest-only mortgages D. Both B and C C. mortgages with balloon payments D. thirty-year fixed-rate mortgages 2. A nonprofit organization provides banking services to the members of a large labor union. 7. Many savings and loan associations faced in- This would be known as a: solvency as a result of questionable investment A. credit union practices during the: B. loan correspondent A. 1930s C. mutual savings bank B. 1950s D. savings and loan association C. 1980s D. 1990s 3. A residential lender is not a depository institu- tion, but rather acts as a loan correspondent, 8. The bill that imposed new rules on savings and originating loans for large investors like insur- loan associations as a result of the S&L crisis ance companies. This lender would be known was the: as a: A. Glass-Steagall Act A. mortgage company B. Depository Institutions Deregulation and B. mutual savings bank Monetary Control Act C. savings and loan association C. Garn-St. Germain Depository Institutions D. secondary market entity Act D. Financial Institutions Reform, Recovery, and Enforcement Act 4. An intermediary who does not make loans but brings together lenders and borrowers for a commission is a: 9. By the end of the S&L crisis, the majority of A. loan originator all residential loans were being originated by: B. credit union A. commercial banks C. thrift institution B. mortgage companies D. depository institution C. savings and loan associations D. savings banks 5. An independent mortgage company: A. is a depository institution 10. The introduction of automated underwriting B. is affiliated with a commercial bank systems and credit scoring has: C. is subject to the same regulations as com- A. shortened the amount of time it takes to mercial banks originate a loan D. may originate residential loans, but does B. reduced the costs of loan processing not accept deposits C. increased the costs of loan processing D. Both A and B 9  Financing Residential Real Estate Instructor Materials 11. A life insurance company uses loan originators to make loans in various local markets. The life insurance company is an example of a: A. loan correspondent B. retail lender C. warehouse lender D. wholesale lender 12. All of the following are examples of mortgage products that contributed to the 2007 financial crisis except: A. piggyback loans B. negative amortization loans C. real estate investment trusts D. low entry (option) ARMs 13. The term used to describe the artificial increase of property values (that contributed to millions of defaults and foreclosures) is: A. secondary market B. housing bubble C. toxic asset D. subprime crisis 14. A subprime loan is characterized by which of the following? A. Higher rates and fees B. More flexible underwriting standards C. Risk-based pricing D. All of the above 15. Because of their emphasis on savings accounts for small depositors, savings banks and sav- ings and loan associations are also commonly known as: A. credit unions B. people’s banks C. savings banks D. thrifts 10  Chapter 4: The Mortgage Industry Answer Key 1. D. As part of its reaction to the mortgage 8. D. In the wake of the S&L crisis of the crisis, in 2008 the government took 1980s, Congress passed the Financial over control of Fannie Mae and Fred- Institutions Reform, Recovery, and die Mac.. Enforcement Act (FIRREA). This law created new rules for savings and loan 2. A. A credit union is a nonprofit coop- associations, and reorganized the fed- erative organization that provides eral agencies that oversaw them. financial services to members of a particular group, such as members of 9. D. Before the S&L crisis, savings and a labor union or employees of a large loans controlled the most market share company. in residential lending. By the 1990s, though, mortgage companies origi- 3. A. A mortgage company is a residential nated the majority of residential loans. mortgage lender that does not ac- cept deposits and focuses its entire 10. D. Technological changes such as auto- business on originating and selling mated underwriting have sped up the mortgage loans. loan application and approval process, and reduced the cost of loan processing. 4. A. A loan originator helps borrowers find a loan. And once a loan originator ar- 11. D. A wholesale lender does not work ranges a loan for a borrower, he will directly with home buyers. Instead, be paid through a commission. (Loan the lender remains behind the scenes, originators can also be called loan of- making loans through loan correspon- ficers or mortgage brokers.) dents. 5. D. An independent mortgage company 12. C. Loans that had negative amortization originates loans. It is not a depository features created problems for borrow- institution, and is not subject to the ers during the most 2007 financial same regulations as depository insti- crisis, as did loans that allowed for up tutions. to 100% financing and loans with low entry rates that reset at higher rates 6. D. The FHA-insured loan program al- in the future. A real estate investment lowed loans to be paid off over 30 trust provides funding to builders. years at a fixed rate of interest; this quickly became the standard mortgage in the U.S. 7. C. Hundreds of federally insured savings and loans became insolvent during the crisis of the 1980s. 11  Financing Residential Real Estate Instructor Materials 13. B. The term “housing bubble” is often used to describe the period when hous- ing prices soared unrealistically high. When the bubble burst, millions of borrowers were left with loans they couldn’t afford and houses that were worth less than the remaining loan bal- ance. 14. D. A subprime loan usually offers less stringent underwriting standards to buyers with credit problems or unusual needs. The greater risk is offset by charging higher rates and fees. 15. D. Savings and loans are sometimes known collectively as “thrifts” or the “thrift industry.” 12  Chapter 4: The Mortgage Industry PowerPoint Thumbnails Use the following thumbnails of our PowerPoint presentation to make your lecture notes. Financing Residential Real Estate Lesson 4: The Mortgage Industry © 2018 Rockwell Publishing Introduction This lesson will cover: ⚫ steps in residential mortgage process ⚫ participants in process ⚫ government intervention in mortgage industry during various financial crises ⚫ mortgage industry and recent economic crisis © 2018 Rockwell Publishing Introduction Terminology concerning mortgage industry isn’t always used consistently throughout industry. ⚫ Definitions here may not match those encountered in the field. ⚫ Terms such as loan origination, loan officer, and mortgage broker used differently in different contexts. © 2018 Rockwell Publishing 13  Financing Residential Real Estate Instructor Materials Overview of Mortgage Process Before loan is made: ⚫ Home buyer applies for loan. ⚫ Loan originator helps buyer with application and submits it to lender. ⚫ Lender approves and funds loan. After loan has been made: ⚫ Lender may keep loan in portfolio or sell it on secondary market. ⚫ Servicer collects payments, handles other administrative tasks. © 2018 Rockwell Publishing Loan Origination Loan originator who helps buyer may be: ⚫ a loan officer, employed by a particular lender ⚫ a mortgage broker, an independent agent working with more than one lender Loan may be originated in: ⚫ a retail transaction (direct lending) ⚫ a wholesale transaction (indirect) © 2018 Rockwell Publishing Loan Origination Retail transactions Retail lending: traditional form of financing. ⚫ Buyer applies to Acme Bank. ⚫ Loan originator who works with buyer is loan officer employed by Acme. ⚫ Loan officer submits application to Acme’s underwriting department. ⚫ If approved, Acme funds loan. © 2018 Rockwell Publishing 14  Chapter 4: The Mortgage Industry Loan Origination Wholesale transactions Wholesale lending: came into use in 1990s. Example: Buyer applies to Zenith Mortgage. Zenith, acting as intermediary, may be: ⚫ loan correspondent processing loan on behalf of national lender, MegaBank, or ⚫ mortgage broker submitting application to one or more lenders, including MegaBank. © 2018 Rockwell Publishing Loan Origination Wholesale transactions By lending indirectly, through local loan correspondents or mortgage brokers, wholesale lenders reduce their overhead. Don’t have to pay for office space or have employees every place they make loans. © 2018 Rockwell Publishing Loan Origination Loan correspondents Loan correspondents make loans for large investors (life insurance companies, pension funds, wholesale lenders). ⚫ Correspondent may handle entire origination process and underwriting, but funds ultimately come from investor/ wholesale lender. ⚫ Local lending institutions and mortgage companies often act as loan correspondents. © 2018 Rockwell Publishing 15  Financing Residential Real Estate Instructor Materials Loan Origination Mortgage brokers Mortgage broker a go-between, not a lender. ⚫ Brings borrowers and lenders together in exchange for commission. ⚫ Helps buyer choose lender, submit application. ⚫ May give preliminary approval per lender’s underwriting rules. ⚫ Doesn’t underwrite, approve, or fund loan. © 2018 Rockwell Publishing Loan Origination Mortgage brokers Table-funded loan: creates impression that mortgage broker is lender. ⚫ Mortgage broker designated as originating lender in loan documents. ⚫ Loan actually funded by wholesale lender “at the closing table.” ⚫ At closing, broker assigns loan rights to true lender, receives service release premium. ⚫ Raises consumer protection issues. © 2018 Rockwell Publishing Loan Origination Regulation of loan originators Housing and Economic Recovery Act: 2008 law addressing mortgage crisis, includes Secure and Fair Enforcement for Mortgage Licensing Act. ⚫ SAFE designed to help prevent abusive, predatory practices during loan origination. © 2018 Rockwell Publishing 16  Chapter 4: The Mortgage Industry Regulation of Loan Originators SAFE licensing / registration rules SAFE requires residential mortgage loan originators to be either federally registered or state-licensed. ⚫ Mortgage loan originator employed by depository institution or subsidiary must be federally registered. ⚫ All other loan originators must be state licensed. © 2018 Rockwell Publishing Regulation of Loan Originators SAFE licensing / registration rules Real estate agents: ⚫ generally exempt from SAFE licensing rules ⚫ but must have originator’s license if compensated by lender for helping to arrange loan © 2018 Rockwell Publishing Regulation of Loan Originators Other SAFE provisions SAFE: ⚫ requires uniform license applications and reporting requirements for states ⚫ improves information tracking across state lines (background checks, finger-printing, etc.) ⚫ enhances consumer protection and anti- fraud measures ⚫ imposes fiduciary duties on loan originators © 2018 Rockwell Publishing 17  Financing Residential Real Estate Instructor Materials Regulation of Loan Originators Originator’s fiduciary duties Traditionally, mortgage broker: ⚫ wasn’t buyer’s agent ⚫ didn’t have duty to act in buyer’s best interests Under law in some states, mortgage brokers owe fiduciary duties to buyers. Now SAFE imposes fiduciary duties as a matter of federal law. © 2018 Rockwell Publishing Summary Loan Origination Loan originator Loan officer Mortgage broker Retail lending Wholesale lending Loan correspondent Table-funded loan SAFE © 2018 Rockwell Publishing Mortgage Lenders After helping buyer prepare loan application, loan originator submits it to mortgage lender. ⚫ Lender reviews application and decides whether to approve or reject it. ⚫ If application approved, lender will fund buyer’s loan. © 2018 Rockwell Publishing 18  Chapter 4: The Mortgage Industry Types of Mortgage Lenders Main sources of residential mortgage financing in primary market: ⚫ depository institutions ⚫ commercial banks ⚫ thrift institutions (savings banks and S&L associations) ⚫ credit unions ⚫ mortgage companies © 2018 Rockwell Publishing Types of Mortgage Lenders Depository institutions Depository institutions use customers’ deposits to make loans. ⚫ Pay interest to depositors. ⚫ Collect interest from borrowers. Most are involved in residential mortgage lending to some degree. ⚫ Central focus for some, but not for others. © 2018 Rockwell Publishing Types of Mortgage Lenders Commercial banks Commercial banks originally developed to serve merchants, businesses. ⚫ Residential mortgages weren’t big part of their lending. ⚫ Regulatory changes, larger secondary market increased residential lending. ⚫ Commercial loans still primary focus, but today also have significant share of home loan market. © 2018 Rockwell Publishing 19  Financing Residential Real Estate Instructor Materials Commercial Banks Federal or state charter Commercial banks are either: ⚫ national banks chartered by federal government ⚫ state banks chartered by state government © 2018 Rockwell Publishing Commercial Banks History Investment bank: securities firm (stock brokerage). ⚫ Raises capital for corporations. ⚫ Arranges issuance of government and corporate bonds. ⚫ Manages corporate finances. ⚫ Handles mergers and acquisitions. ⚫ Provides investment advice to clients. © 2018 Rockwell Publishing Commercial Banks History Glass-Steagall Act: adopted in 1933, required banks to choose between commercial and investment banking services; could not provide both. ⚫ Prohibited banks from involvement in insurance business. ⚫ Intended to protect public from conflicts of interest. © 2018 Rockwell Publishing 20  Chapter 4: The Mortgage Industry Commercial Banks History Glass-Steagall Act gradually undermined and eventually repealed in 1999 by Financial Services Modernization Act. ⚫ Now legal for holding company to have commercial bank, securities firm (investment bank), and insurance company as subsidiaries. © 2018 Rockwell Publishing Types of Mortgage Lenders Thrift institutions Thrifts: emphasize consumer financial services such as personal savings accounts, home loans, consumer loans. Thrifts include: ⚫ savings banks ⚫ S&L associations Like commercial banks, thrifts may have either federal or state charter. © 2018 Rockwell Publishing Thrift Institutions Savings banks Savings banks: began in 19th century, offering financial services to small depositors. ⚫ A.k.a. mutual savings banks because originally organized as mutual companies owned/operated by and for depositors. ⚫ Today may be organized either as mutual company or as stock company. © 2018 Rockwell Publishing 21  Financing Residential Real Estate Instructor Materials Thrift Institutions S&L associations Savings and loan associations: also began in 19th century: ⚫ by local communities to finance home construction ⚫ members pooled funds, took turns using money to build houses ⚫ after financing needs satisfied, association would dissolve © 2018 Rockwell Publishing Thrift Institutions Deregulation, expansion of services Traditional emphasis on home loans, savings accounts (basis for term “thrifts”). ⚫ Originally restricted by law to providing limited services. ⚫ Deregulation in 1980s allowed them to offer more services. ⚫ Now provide full range of financial services. © 2018 Rockwell Publishing Types of Mortgage Lenders Credit unions Credit union: a nonprofit depository institution that serves members of a particular group. ⚫ May have federal or state charter. ⚫ Originally didn’t make mortgage loans. ⚫ Specialized in small, unsecured personal loans. © 2018 Rockwell Publishing 22  Chapter 4: The Mortgage Industry Credit Unions Expanding into mortgage lending Later, credit unions started making home equity loans as well. ⚫ Home equity loan: mortgage on equity in home borrower already owns. ⚫ Home equity loans generally short-term. Deregulation in 1980s allowed credit unions to offer long-term mortgages. © 2018 Rockwell Publishing Credit Unions Advantages of nonprofit status Because they are nonprofits, credit unions are generally exempt from taxation. That allows them to offer: ⚫ lower interest rates on loans ⚫ higher rates on deposits © 2018 Rockwell Publishing Summary Depository Institutions Commercial banks Investment banks Glass-Steagall Act Thrift institutions Savings banks Savings and loan associations Credit unions Home equity loans © 2018 Rockwell Publishing 23  Financing Residential Real Estate Instructor Materials Types of Mortgage Lenders Mortgage companies First U.S. mortgage companies were established in 1930s. ⚫ Not depository institutions. ⚫ Business focused exclusively on mortgage lending and related services. ⚫ Also called mortgage banking companies or mortgage bankers. © 2018 Rockwell Publishing Mortgage Companies Independent vs. associated Original mortgage companies unconnected with banks or other depository institutions. ⚫ Now some associated with depository institutions as direct subsidiaries or affiliates. ⚫ Companies not associated with depository institution are called independent mortgage companies. © 2018 Rockwell Publishing Mortgage Companies Independent vs. associated Independent mortgage companies previously less regulated than other mortgage providers. But Consumer Financial Protection Act (2010) subjects them to stricter regulation: ⚫ Consumer Financial Protection Bureau (CFPB) has primary rulemaking/ enforcement authority. © 2018 Rockwell Publishing 24  Chapter 4: The Mortgage Industry Mortgage Companies Business activities Some mortgage companies engage in mortgage brokerage activities as well as mortgage banking activities. Example: “Zenith Mortgage” could be: ⚫ mortgage banker (a lender) ⚫ mortgage broker (a go-between) ⚫ combination of the two © 2018 Rockwell Publishing Mortgage Companies Sources of funds for lending Mortgage companies are not depository institutions; can’t use depositors’ savings to fund loans. Instead, may: ⚫ act as loan correspondent for large investors or wholesale lenders ⚫ draw on line of credit from commercial bank, then sell loans, use proceeds to pay off bank, make more loans © 2018 Rockwell Publishing Mortgage Companies Sources of funds for lending Mortgage companies keep few if any loans in portfolio. Loans are either made on behalf of large investor or sold on secondary market. © 2018 Rockwell Publishing 25  Financing Residential Real Estate Instructor Materials Types of Mortgage Lenders Alternative financing sources Sometimes private individual makes mortgage loans to home buyers on small scale. Private lending business: ⚫ may be legal, or ⚫ may violate state licensing laws, usury laws, disclosure laws, or predatory lending laws © 2018 Rockwell Publishing Types of Mortgage Lenders Alternative financing sources Most important alternative source of financing for home buyers is home seller. ⚫ Seller may provide some or all of financing. ⚫ Common when institutional loans hard to get or interest rates high. © 2018 Rockwell Publishing Summary Mortgage Companies, Alternatives Mortgage company Mortgage banker Independent mortgage company Private lenders Home sellers © 2018 Rockwell Publishing 26  Chapter 4: The Mortgage Industry Government Intervention in the Mortgage Industry Federal government has intervened in mortgage industry in many ways. ⚫ Creation of secondary market entities. ⚫ Other large-scale interventions during: ⚫ Great Depression in 1930s ⚫ S&L crisis in 1980s ⚫ 2007 economic crisis © 2018 Rockwell Publishing Government Intervention The Depression Tremendous economic growth as U.S. expanded westward in 19th century. ⚫ Investment capital poured into real estate, including homes. ⚫ Mortgage business booming in early 20 th century. 1929 stock market crash was followed by general economic collapse. © 2018 Rockwell Publishing The Depression Foreclosure epidemic After stock market crash: ⚫ sharp rise in unemployment ⚫ hundreds of thousands defaulted on mortgages ⚫ many financial institutions failed ⚫ mortgage lending and home construction virtually ceased © 2018 Rockwell Publishing 27  Financing Residential Real Estate Instructor Materials The Depression New Deal initiatives New Deal: broad plan to pull U.S. out of economic crisis. ⚫ Included intervention in real estate financing. ⚫ Several agencies/programs created under New Deal still exist, including: ⚫ FHA ⚫ FHLBB ⚫ FNMA © 2018 Rockwell Publishing The Depression Transforming home mortgages Introduction of long-term, fixed-rate, amortized mortgage loans: ⚫ FHA-insured loans, 20-30 year terms ⚫ easier for home buyers to avoid default By 1940s, 30-yr. fixed loans were standard of the industry. © 2018 Rockwell Publishing The Depression Transforming home mortgages During housing boom of first few years of new millennium, many buyers chose loans with features such as interest-only payments. ⚫ Contributed to 2007 crisis. ⚫ Lenders and buyers now turning back to standard mortgages created after Depression. © 2018 Rockwell Publishing 28  Chapter 4: The Mortgage Industry Government Intervention Savings and loan crisis From 1950s to 1980s, S&Ls were largest source of mortgage financing. © 2018 Rockwell Publishing Savings and Loan Crisis Deregulation In late 1970s and early 1980s, market interest rates very high and unstable. Regulations limited how much interest S&Ls could pay depositors. ⚫ Made it difficult to offer attractive returns. ⚫ S&Ls lost deposits to more competitive investments. © 2018 Rockwell Publishing Savings and Loan Crisis Deregulation Congress responded by easing the limits on the S&Ls. © 2018 Rockwell Publishing 29  Financing Residential Real Estate Instructor Materials Savings and Loan Crisis Deregulation Freed up, S&Ls tried new, riskier investments. These mostly failed. ⚫ Hundreds of federally insured S&Ls became insolvent. ⚫ Led to $124 billion industry bail-out by federal government. © 2018 Rockwell Publishing Savings and Loan Crisis Reform Congress passed Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) in 1989: ⚫ imposed new rules on S&L lending ⚫ reorganized federal agencies that supervise financial institutions © 2018 Rockwell Publishing Savings and Loan Crisis Changing market shares In wake of S&L crisis, market shares of different types of mortgage lenders changed. Mortgage companies replaced thrifts as the dominant source of mortgage funds. © 2018 Rockwell Publishing 30  Chapter 4: The Mortgage Industry Savings and Loan Crisis Changing market shares Factors behind shift in market shares: ⚫ S&L crisis ⚫ decline in number of S&Ls ⚫ growth of secondary market © 2018 Rockwell Publishing Summary Great Depression, S&L Crisis The Depression New Deal 30-year, fixed-rate, amortized loans Savings and loan crisis Deregulation FIRREA © 2018 Rockwell Publishing Government Intervention Mortgage and financial crisis Crisis in mortgage industry led to wider credit crunch and huge losses in financial markets. ⚫ Difficulties spread throughout U.S. and global economies. © 2018 Rockwell Publishing 31  Financing Residential Real Estate Instructor Materials Mortgage and Financial Crisis Factors contributing to crisis: ⚫ growth of subprime market ⚫ relaxation of underwriting standards ⚫ looser rules, lax oversight © 2018 Rockwell Publishing Mortgage and Financial Crisis Foreclosure crisis When home values dropped: ⚫ owners found themselves “underwater” ⚫ with no equity, owners couldn’t refinance ⚫ payment shock when ARM payments increased sharply ⚫ foreclosure rate began to climb © 2018 Rockwell Publishing Mortgage and Financial Crisis Foreclosure crisis Mounting foreclosures led to: ⚫ “toxic” mortgage-backed securities ⚫ bankrupt mortgage lenders ⚫ failure of investment banks © 2018 Rockwell Publishing 32  Chapter 4: The Mortgage Industry Mortgage and Financial Crisis Government response Government actions: ⚫ Housing and Economic Recovery Act (HERA): offered refinancing options for struggling homeowners ⚫ Takeover of Fannie Mae and Freddie Mac ⚫ TARP: Several hundred billion dollar bailout of financial institutions and other companies ⚫ 2010 Dodd-Frank Act: toughened government regulations © 2018 Rockwell Publishing Summary Mortgage and Financial Crisis Subprime loans Underwater homeowner Toxic MBS HERA / TARP Dodd-Frank reforms © 2018 Rockwell Publishing 33