Funding Sources for Mortgages
A. Bankers Money
When we speak of the distinction between bankers and mortgages, in the former, we are referring to those who provide funding to property buyers out of their own reserves.
B. Banks: Funding Sources
Those that are members of the Federal Home Loan Bank System can pledge mortgage loans and mortgage backed securities as collateral for funding advances, can issue brokered certificates of deposit, and/or can derive funds through the ongoing management of risks at various stages during the life of the loan.[i]
While a range of methods exist, traditionally, banks financed their mortgage lending through deposits received from their customers. This, though, limited the amount of mortgage lending they could do.
C. Brokers: Funding Sources
To entice the borrower, the broker may opt to reduce the loan amount by their commission fee. In lowering the pricing, they are able to compete, and often times undercut, the loan costs of retail establishments.
D. Mortgage Backed Securities
In the United States, persons who take out mortgages have a range of options in terms of how they pay off their home loan. Beyond simply paying their required monthly fee, they can elect to pay more each payment (known as a curtailment) or they can opt to pay off the loan in full (known as prepayment).
Yet, because both the curtailment and prepayment options result in altering the current loan principal, the monthly flow of what is known as a Mortgage Backed Security (MBS) is not able to be predicted. This then, presents an associated risk factor for those who invest in mortgage backed securities.
Chartered by the U.S. government, Fannie Mae was created as a business whose purpose it was to buy Federal Housing Administration (FHA) and Veteran Affairs (VA) mortgages on the secondary market, merge them and sell them as MBS to investors on the open market. Although Fannie Mae began as a public company, it later became privatized.
Note: Recently, in 2008, Fannie Mae went back under government oversight as part of a buyout plan.
According to the Bond Market Association (BMA), at the end of the last quarter of 2007, the total market value of all outstanding U.S. MBS was approximately $ 7.2 trillion.
Further statistics provided by the BMA show the growth in size of the issuance in the U.S. of MBS for the past several years:
- 2005 - USD 1,9667 billion.
- 2006 - USD 1,988 billion.
- 2007 - USD 2,050 billion.
F. Mortgage Backed Securities: Uses
Reasons why originators (lenders) of mortgages opt to finance their activities by issuing mortgage backed securities include:
- To liquidate individual financial assets and make them into desirable instruments of trade in capital markets.
- Replenish mortgage originator funds so that they may continue originating mortgages for other clients.
- Tool of U.S. banks whereby they can specify a monetary amount for the credit spread that exists between the origination of a mortgage orchestrated as a private transaction and the yield brought about through the issuing of a bond. Predominately, this is a public market transaction.
- Lower cost financing option as compared with other bank and capital markets financing alternatives.
- Diversification method whereby mortgage issuers offer clients a range of debit and equity financing options.
- Allows mortgage issuers to remove assets from their balance sheet thereby helping improve financial ratios, make better use of capital, and be compliant with risk based capital standards.
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