Where the Lender Fits In

The Lender is the entity that deals directly with the customer in originating a mortgage, commits to fund and then closes on the mortgage. It can use its own money to fund mortgage, use an investor’s money or broker the mortgage out to another funding source. Every lender operates in a way that best suits its needs. A large lender with substantial cash reserves may be closing the majority of mortgages with its own money whereas a small lender will elect to close most of its mortgages using investor’s money. A savings bank would be an example of a large lender. They have a depositor base supplying the cash needed to fund its own mortgages. A mortgage banker would be an example of a small lender. Not having access to a depositor base it will need to depend on investors to fund mortgages.

A lender utilizing its own funds writes its own underwriting standards and sets its own pricing. A lender that uses investor funds will be using the investor’s underwriting standards and is more limited in setting pricing. Now let’s look at the impact each style of operation has on the mortgage market in general.

A lender that uses its own capital to fund mortgages is called a portfolio lender. As the name implies, this lender is holding all their mortgages in their own portfolio. The underwriting standards they use will directly influence the performance of the portfolio. If they are too conservative, they may not be writing enough mortgages to generate the profits needed. If they are too liberal, the performance of the portfolio will be poor due to a higher than expected default rate. The portfolio lenders suffered the same problems that the wholesalers faced in this market. The combination of a desire to increase their volume of originations and turning a blind eye to the risk exposure of their underwriting standards, leads them down the path to a non-performing portfolio.

It’s a little different with the smaller lender. Here, thier wholesalers and investors are dictating the underwriting standards. A mortgage banker is interpreting those guidelines that have been given to him. The act of underwriting the mortgage application is one of matching the attributes of the applicant to the underwriting standards. The mortgage banker’s contribution to our current problems is their liberal interpretation of the underwriting standards. They were closing on mortgages that they should not have closed on. Common sense was ignored, in order to keep the volume of closed mortgages as high as possible. The moertgage banker didn’t feel responsible since they were following the guidelines of their investors. The investors, however, saw it differently and quickly stopped funding their mortgages with an end result of driving the mortgage banker into bankruptcy.

In theory, lenders could have prevented a lot of our current problems. Using a common sense interpretation of underwriting standards, a more diligent investigation of the details of the purchase transaction and the financial profile of the applicant, our problems would be much less severe. Few lenders took this approach, preferring to “go with the pack” and do the same thing their competitors were doing. This seemed to be the safer path. Investors were looking to buy high yielding mortgages, the rating agencies gave these pools of mortgages high marks, the population was demanding that they be given mortgages and the Federal government was praising the high percentage of Americans who now owned their own homes. Additionally, the expanding mortgage market was keeping the country’s economy strong. In such an environment, it’s extremely difficult for any person or company to break away from the pack.

This, in no way, is meant to minimize the responsibilities of the lenders for this mortgage market nightmare. It is being presented to give you an overall prospective of how we’ve gotten to where we are. They only way we can avoid making the same mistakes again, is to identify the underlying factors that caused the problem in the first place.