A mortgage broker acts as an intermediary who sources mortgage loans on behalf of individuals or businesses. The banks have used brokers to outsource the job of finding and qualifying borrowers, and also to outsource some of the liabilities for fraud and foreclosure onto the originators through legal agreements.
There are approximately 53,000 mortgage brokerage companies that employ an estimated 418,700 employees and originate more than 50% of all residential loans in the U.S.. The mortgage broker industry is regulated by 10 federal laws, five federal enforcement agencies and over 49 state laws or licensing boards.
Mortgage brokers participate in more than 68% of home loans originations. The remaining 32% is retail done through the lender's retail channel, which means the lender does not go through a broker.
Difference between a mortgage broker and a loan officer
A mortgage broker works as a conduit between the buyer and the lender, the loan officer typically works directly for the lender. Most states require the mortgage broker to be licensed. States regulate lending practice and licensing, but the rules vary. Most have a license for those who wish to be a "Broker Associate", a "Brokerage Business", and a "Direct Lender".
A mortgage broker is normally registered with the state, and personally liable (punishable by revocation or prison) for fraud for the life of a loan. A loan officer works under the umbrella license of their current institution. Both positions have legal, moral, and professional liabilities to prevent fraud and fully disclose loan terms.
Typically, a mortgage broker will make more money per loan than a loan officer, but a loan officer can utilize the referral network available from the lending institution to sell more loans. There are mortgage brokers and loan officers at all levels of experience.
How they make money
The mortgage broker gets paid by the banks / insurance companies (that end up owning the mortgages) for taking on some risk, and for finding clients, helping with collections, etc..
In exchange for assuming that risk, the broker gets paid:
- origination fee (paid by bank / insurance company) = 1% of value of loan
- collection agent fees: small percentage = 0.02% to 0.04% of the remaining balance
How they deal with interest rate risk (hedging)
There are two possible scenarios, but the essential lesson is that he uses interest-rate futures and makes sure that the two assets (his mortgage and the futures contracts) move in opposite directions with regards to interest rates. Risk is therefore offset by an offsetting transaction in the futures market. The only thing to watch for is that the two assets might not have identical reactions to changes in interest rates, becasue of differences in maturity time, and a less than perfect correlation between the two assets. The hedging is only really perfect if there is perfect correlation.
1. Example: Mortgages (short position)
A very common example of short hedges may occur when a mortgage broker builds up an "inventory" of mortgages before selling them to an insurance company. This occurs when a mortgage banker first promises to his clients that he will deliver money in exchange for the promise (asset) that they will pay principal + interest for the next 30 years. That, in and of itself, is like buying a forward contract, but dont focus on that right now. First, think of it in a simplified manner...he will receive an asset in 60 days, and he plans on reselling that asset to someone else. That, in its essence, is just like an inventory example shown above (like having an expected inventory of mortgages).
The broker would be worried that a raise in interest rates could decrease the value of his inventory of mortgages. (note that mortgages, like all bond, decrease in value when interest rates rise). A decrease in the value of his inventory would hurt him because he wouldn't be able to sell the inventory for as high of a price as he would like. That would mean making less money, or even taking a loss (if the inventory were to devalue too much). This risk is something that most mortgage brokers are unwilling to take.
Again, the solution will be to sell (short) futures contracts. But, in this case he will not find mortgage for trade on a futures market, so he will look for another asset that behaves similarly to his asset. The most common asset to use is the Treasury Bonds, which also decreases in value when interest rates rise (and increase in value when interest rates fall). This Treasury Bond will act as a proxy for his mortgages.
He sells Treasury Bonds in the futures markets, which means that he is short on Tbonds. If the price were to fall, he would make money. Hopefully enough to offset the loss he will face on his mortgages.
Summary:
If he is afraid that his mortgages will lose value, then he wants to sell them short in the futures market. But, since mortgages don't trade, he instead sells Treasury Bonds short in the futures market. That way, if interest rates rise, although he will lose money on his mortgages (inventory before he sells them to a bank), he will make off-setting money on the treasury bonds. If he carefully plans the right number of treasury bonds to purchase, he should be able to (almost) completely insulate himself from interest rate risk.
Summary:
2. Example: Mortgages (long)
Your should use a long hedge if you are hurt by price increases. In order to hedge your potential losses on your primary asset (which looses money when prices go up), you purchase a second asset that earns money when prices go up.
In the mortgage broker business, what scenario could occur where he would be hurt if the mortgage prices went up?
Imagine a case where the broker would have already sold the mortgages to an insurance company (or bank) at a fixed price, and then he goes out into the market looking for clients. If they write a mortgage contract, then that contract becomes his asset that he resells to the insurance company (at the fixed price). The trouble could come into the picture if the interest rates change between the time he arranges the fixed price with the insurance company, and the time he buys the contracts from the individuals.
If interest rates fall, the mortgages will be more expense (for him to buy). He will want to protect against a fall in interest rates buy buying another asset that would increase in value itself if the interest rates would fall....thereby offsetting his losses on his mortgages. In this case, he would buy Treasury Bonds in the futures market. If interest rates were to fall between now and then, his TBond futures would become more valuable, but his mortgages would become less. If he correctly purchased the right number of Tbonds, he should offset most of this risk.
Risk is therefore offset by an offsetting transaction in the futures market. The only thing to watch for is that the two assets might not have identical reactions to changes in interest rates, because of differences in maturity time, and a less than perfect correlation between the two assets. The hedging is only really perfect if there is perfect correlation.
Housing index:
There are three indexes out there. Only one is good. See S&P Case-Shiller index
Be very careful of the REALATORS index....which is too optimistic, and also of the FEDERAL Reserve index, which is based on the data from Fannie May, Freddie Mac....because they dont include subprime lending, and are therefore too optimistic as well.
The only good, best index is from Case/ shiller.
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