In order for you to get your best deal on a mortgage you must first understand the types of companies that are offering mortgage products. Learn how they make their money and half the battle is won! These mortgage companies can be simplified as:
Brokers
Broker/Lenders
Mortgage Lenders
Banks
Before we continue, I need to stress this single point. There ain’t no free lunch! All companies are in business to make a profit. If your intention is to get someone to work on your loan for free, you will get what you pay for.
Mortgage companies will make their money in one or more of these four categories, no exceptions.
Fees - Fees charged to the borrower, seller, builder or realtor included in the closing cost of the loan. They are often referred to as “front end fees”. These take the form of junk fees, (fees that are in excess of the actual cost of the service or are not representative at all of any service), origination fees and discount fees. More on this.
Yield Spread - Yield spread is when you qualify for one rate and are sold or closed with a higher rate. The company then makes an economic profit in the form of basis points against the loan amount from the institution they plan to sell the loan to. Incidentally, this is how “no closing cost” loans are done.
Securitization - This is when a lender packages loans as a group, FHA, Conventional, B or C grade loans and sells them on the securities market. A good example is an FHA loan. These groups of loans have a set, if you will, default rate. We know as lenders that xxx amount of these loans will go into default. We also know that xxx amount of these loans will go to term and pay all the interest on the loan scheduled to be paid. These loans as a group represent a dollar amount to other lenders who need to fulfill “money line” quotas. Therefore they can be sold at a premium above the face value of the loans they encompass.
Servicing - This is earning a profit the old fashioned way. Actually holding the loans that you originate to collect the interest that accrues on them that are above the price of the money you purchased to make the loan. Incidentally, this is the least used way institutions use to earn a profit.
This list below simplifies a large diversity of mortgage lending businesses; to a greater extent most mortgage companies will fall into one or more of these business models:
Brokers
Brokers do just what the name implies they broker. They are registered or work in conjunction with a host of different lenders in order to offer a wide array of products. Each bank, lender or correspondent that they deal with has its own niche and lends diversity to the pool of loan programs the broker can offer. It is not uncommon to find a broker with dozens of correspondent lenders. Brokers typically do better with credit challenged clients.
Pros - They can offer many more programs than most traditional lenders and banks. They are usually smaller companies and can work with consumers on a one on one basis. They can usually get you a better rate than you would get if you were to directly apply with the institution they are using.
Cons - They have no underwriting authority. They are at the mercy of the banks and lending institutions they deal with as far as lending decisions. They typically take longer for approvals and have higher fees. They are charged “broker fees” from the institutions they deal with and pass them directly to the consumer in one form or another. They pull your credit and submit it to other banks and lenders to re-pull your credit to see if you qualify for the programs their investor offers. This creates more inquiries on your bureau, which typically brings down your FICO score.
How They Make a Profit - Brokers tend to make their money in fees and yield spread. Brokers offering “no closing cost loans” are selling you a higher rate to re-capture the actual cost of doing the loan plus make a profit. They will typically have junk fees that represent profit to the broker i.e. processing fees, funding fees, underwriting fees. The reason I call them junk fees is most if not all brokers do not underwrite their loans, pay their processors by the hour and table fund in the individual investors name they used to get you the loan.
Broker/Lenders
Broker/Lenders work very much like the Broker category above. The only difference is that they possess a line of credit or have a slush fund from which they “lend” from. Like the broker, they have the loans earmarked for immediate sell to individual investors to get their money line replenished for the next loan.
Pros - They can offer many more programs than most traditional lenders and banks. They are usually smaller companies and can work with consumers on a one on one basis. They can usually get you a better rate than you would get if you were to directly apply with the institution they are using. Added “Pro”, they have the ability to close loans on their timetable, which is an advantage over just plain brokers.
Cons - They have limited underwriting authority. They are at the mercy of the banks and lending institutions they deal with as far as lending decisions. They typically take longer for approvals and have higher fees. They are charged “broker fees” from the institutions they deal with and pass them directly to the consumer in one form or another. By having “Lender Status” in some states like Georgia, they can usurp the 5% cap on fee’s and profit by not disclosing the profit they make on yield spread by selling the loan at a premium.
How They Make a Profit - Broker/lenders tend to make their money in fees and yield spread. Brokers offering “no closing cost loans” are selling you a higher rate to re-capture the actual cost of doing the loan plus make a profit. They will typically have junk fees that represent profit to the broker i.e. processing fees, funding fees, underwriting fees. These are typically the companies advertising “we are a lender” no closing cost and so on.
Mortgage Lenders
Lenders typically have their own set of guidelines and programs and may tend to specialize in a specific niche of the market. They sell their loans and service their loans respectively. Typically the average mortgage lender, Opteum Financial, Homebanc, Countrywide, will securitize their loans 2 to 5 times a year. That is, they will sell their loans on the open market in bundles such as Fannie Mae, Freddie Mac and FHA insured loans. Also they will usually have “portfolio products”. These are niche products that differ from conventional mortgage types and offer them market share within a certain niche of the market.
Pros - Lenders are usually cookie cutter type organizations with more protocols, guidelines and consumer protection policies in place than the aforementioned companies. This is not to say the other companies aren’t’ customer oriented, it is to say they are characteristically less automated in their procedures. Mortgage lenders are usually where the “expert loan officers” land with their career decisions. Lenders are more apt to give full disclosure, lower fees and some sort of a service guarantee. They are usually the people who have pre-arranged deals with Realtors, Builders and other real estate professionals due to their high volume and multi-state capabilities. Lenders employ their own underwriters, processors and funding departments; this usually means a quicker deal with fewer surprises.
Cons - Mortgage lenders have a higher operating cost over brokers. Typically they will employ their own underwriters, processors and funding department. This may equate in their rates they offer their clients. However, most conventional rates i.e. Fannie Mae, Freddie Mac and FHA loans which represent the bulk of loans done by all mortgage companies are usually within a 1/8th of a point from each other when compared.
How They Make a Profit - Lenders make a profit all four ways mentioned above. They securitize, have fees, generate yield spread and service their loans. The advantage is they have all avenues available and tend to be below average on all of them. In other words, Mortgage Lenders do not need to make all of the profit in fees; they can hold the loan and cut the fees. Or they can sell it in a sensitization package and recoup any losses they may have incurred in the loan. In other words, they have full discretion to do any loan that makes sense.
Traditional Banks
Traditional banks are usually where all loans end up. Banks like, Chase, Bank of America, Wells Fargo and so on. What sets them apart is they are in the business of holding and servicing loans. They are the major buyers of securitized loans from lenders on the open market. The difference is, they are banks that happen to have mortgage departments, not the other way around like lenders.
Pros - Traditional banks are just that, banks; the chance of having your loan sold is far less likely than with the other lenders. Local banks that service their loans can offer the “good ole boy ” network and can usually make loans to farmers and local citizens in small town America with extenuating circumstances. They offer a face to associate with when paying your mortgage if you happen to bank with them. They offer competitive rates, although their most competitive rates can be found offered to their correspondent Brokers to resale to you.
Cons - As mentioned above, banks are unfortunately banks, which happen to have mortgage divisions. They tend to have program A, B and C. If you do not fit one of the programs, tough! Expertise is another con, meaning you are usually speaking with a customer service person instead of a mortgage professional. I hear month after month from customers who have started the process with the “Great American Bank” only to be told they do not fit the guidelines 30 days later.
How They Make a Profit - Banks make profits exactly the way Mortgage lenders do, but the emphasis is shifted to servicing of the loan.
To sum all of this up, ALL mortgage companies are in business to make a nickel or two. The companies that say “Ill do your mortgage for free” or “zero closing cost” are hiding the fees within their rate markup. My recommendation is to work with lenders or brokers who explain this option up front and explain the advantages and disadvantages to structuring your mortgage this way.
Aubrey Clark
Editor
http://lendfast.com
