Your Home Mortgage. How unseen investors generate funds to keep home loans flowing
IN the home-buying business, there's an event called ``the passing.'' The phrase is often said with such a solemn air that it sounds like more than just a passing, but a rite of passage. For someone buying a first home, it is, because this is where the biggest financial event in many families' lives takes place.
With mortgage rates between 10 and 11 percent in most of the United States, this ceremony has been taking place more and more often. But even though the pace of lending has become hectic, each step of the passing must follow the rules of law and tradition.
At a lawyer's office, bank conference room, or mortgage company office, the buyer, seller, attorneys, loan officer, and real estate agents gather to sign and pass around all the legal documents that transfer the property to the new owners and commit them to years of monthly mortgage payments.
Also on this day -- or shortly afterward -- the lender begins looking for a way to ``sell'' that brand-new mortgage to outside investors so that the next time a happily nervous couple comes along, money will be available to lend to them.
By the time the passing arrives, home buyers are all too familiar with the steps that led to it, beginning months earlier when they first thought about a new house. It may have started when they picked a neighborhoood or town where they wanted to live. Then, probably with the help of a real estate agent, they found the house of their dreams -- and maybe the price of their nightmares.
This was followed by negotiations over the price, an offer to buy the house, signing the purchase and sales agreement, making a formal loan application, and getting the house inspected. Behind the scenes, the lender was doing a credit check on the prospective buyers, looking into their employment histories, sources of income, debt, savings, and other financial obligations.
Finally, all of those steps led to this important day.
For a short time during the passing, the home buyer gets to hold a check for the purchase price of the home. In the few minutes it takes to look at it, count the zeros, sign it, and turn it over to the seller's representative, the buyer may even feel rich. Where the money comes from AT this time, in the heady atmosphere of the passing ceremony, it probably never occurs to the buyers to wonder where that money came from. ``It came from the bank'' is all they care to know. But the path that money took may have been even more complicated than the one Mr. and Mrs. Homebuyer just went through.
In all likelihood, the money traveled through a maze known as the ``secondary market'' that involved the lender, a smorgasbord of mortgage-backed securities, and a host of investors including pension funds, insurance companies, and individual investors in the US and abroad.
Until the 1960s, the secondary market hardly existed. Since then, and especially since the mid-1970s, it has become an important factor in stabilizing the housing business, providing a steady source of mortgage money to all parts of the country, and removing some of the big sudden shifts in interest rates.
``The secondary mortgage market allows funds to shift across the country,'' says Andrew S. Carron, senior vice-president at Shearson Lehman Brothers. ``It also has the effect of standardizing the mortgage process, which leads to greater consumer protection.''
Last year, more than three-fourths of all residential mortgages were sold on the secondary market -- up from two-thirds in 1984.
This year, with most home buyers demanding now-affordable fixed-rate loans, almost all mortgages are peddled on the secondary market.
Before this market came into existence, the mortgage supply picture was pretty simple. You went to a bank for a home loan and, if the bank had enough deposits from other customers, it could lend you the money. If there weren't enough deposits, you either had to find another lender or put off buying.
``In the past, lending institutions could only lend the money on hand,'' says John Savacool, director of real estate and construction services at Chase Econometrics, a consulting firm. ``And if they ran out of money, they couldn't lend any more.''
During the 1930s, a lot of people were unable to buy homes because the banks simply did not have the money to lend; nobody else did, either. In the 1970s, the problem returned, though on a much smaller scale, when people took their savings out of banks and similar savings institutions and moved them to higher-yielding money-market mutual funds.
At the same time, if the banks or savings-and-loans kept all the home mortgages they wrote in their own loan portfolios, they were subject to the vagaries of changing interest rates in the open market. If rates rose, many of their depositors would withdraw money from the bank to make more profitable investments elsewhere. Meanwhile, the bank's income-producing assests, the mortgages, shrank as inflation whittled down the value of the incoming monthly payments from borrowers. Birth of the secondary market THE secondary market was born in 1938 when Congress created the Federal National Mortgage Association, or ``Fannie Mae.'' It was empowered to purchase government-guaranteed mortgages from banks, savings-and-loans, and mortgage companies. Fannie Mae gets the money to buy these loans through various types of debt offerings, known as ``mortgage-backed securities.''
After a bank, S&L, mortgage company, or other ``mortgage originator'' has written enough home mortgages, it puts them together in a ``pool'' that it sells to Fannie Mae. With the money it gets from Fannie Mae, the bank can write more mortgages.
Because of the volume of home loans in its portfolio (over $95 billion, making it the largest holder of mortgage securities in the US), Fannie Mae has been able to pretty much set the standard for home loans. The loan application you fill out, and the process the bank uses to approve your loan, are based on Fannie Mae's standards.
This way, investors who purchase securities issued by Fannie Mae don't have to worry that some homeowners won't be able to repay their loans. If there is a problem, they know Fannie Mae will back it up.
That's the simple explanation of the secondary market.
In recent years, the market has become vastly more complicated. In 1968, the Government National Mortgage Association, or ``Ginnie Mae,'' was spun off from Fannie Mae. Two years later, Ginnie Mae introduced the ``pass-through security.'' With this instrument, monthly loan payments are passed from the homeowner, through the lending institution, to the investor. This security consists of a package of residential loans insured by the Federal Housing Administration (FHA) or guaranteed by the Veterans Administration (VA); the security backed by the home loans can be traded like a corporate stock certificate.
Since the early 1980s, these securities have been purchased by thousands of investors in the US and abroad.
In April, Ginnie Mae announced that because so many people had been buying homes or refinancing old, high-interest mortgages into cheaper loans, it had reached its legal limit of $65.3 billion for guaranteeing mortgages. Because so few people ever default on their home loans, very little of this money is actually spent, but these agencies are still required to stay within their mortgage-backing limits.
In May, President Reagan signed a bill raising Ginnie Mae's limit by $60.7 billion more. The Federal Housing Administration, which also hit its ceiling in April, was given $17 billion more to insure home loans.
Another agency, the Federal Home Loan Mortgage Corporation, or ``Freddie Mac,'' was established in 1970. The next year, it began selling securities known as ``mortgage participation certificates,'' or PCs, backed by conventional loans (that is, they are not FHA-insured or VA-guaranteed). These constitute more than 70 percent of all mortgages.
In 1983, Freddie Mac introduced another security, the collateralized mortgage obligation, or CMO, to give investors a choice of short, medium, or long maturities. Investors in CMOs get a payment every six months. Unlike Fannie Mae, Freddie Mac does not keep many of its mortgage securities in its portfolio. Since 1970, it has purchased more than $130 billion in mortgages and sold $115 billion in mortgage securities.
In the last few years, these quasi-governmental agencies have been joined in the mortgage-backed security business by several private companies, including Shearson Lehman Brothers; Sears, Roebuck; Prudential; and Merrill Lynch. Who are the investors? IN addition to individuals, the list of investors in mortgage-backed securities includes pension funds, insurance companies, state housing-finance agencies, and the very same banks and thrifts (S&Ls) that sold those mortgages in the first place. While a banker likes to have the security and income benefits of home mortgages, he or she would rather have someone else bear the risks of early prepayment, interest rate fluctuations, and possible delinquency. So a bank may invest in securities at least partly backed by the same mortgages it wrote a few weeks or months before.
After a group of home loans is packaged and sold to investors on the secondary market, the original lender is responsible for collecting the monthly payments, keeping escrow accounts to pay the homeowner's house insurance premiums and property taxes, and -- through the agencies or companies that issued the securities -- paying the investors.
This is called ``servicing'' the loans, and it provides the bank, thrift, or mortgage company with a small annual fee -- often less than $400 per loan. But with enough loans, it can be a lucrative business.
For example, Dallas-based Lomas & Nettleton, the largest mortgage banker in the country, services more than 700,000 mortgages, says John W. Heamon, a private consultant to mortgage companies.
Those in the business, however, argue that the people who buy the houses also benefit.
``The main beneficiary of the secondary market is the home buyer,'' says Alfred A. Tegel, a vice-president at Cardinal Federal Savings in Cleveland. ``The market provides a wider source of capital and, hopefully, interest rates will not be as volatile.'' TRANSLATING THE LENDERS' LINGO
Where does the money in that fat check you get to hold for a few minutes come from? And where does it go? Here are definitions of some of the terms people in the mortgage business like to throw around:
Secondary market. Where lenders get more money for home mortgages, either by selling pools of mortgages made in the past or by obtaining agreements from investors to purchase mortgages written in the future.
Mortgage originators. Including savings-and-loans, commercial banks, mutual savings banks, mortgage companies, and credit unions.
Conduit. A bank or other institution that buys mortgages and packages them to sell to other investors.
Investors. Including thrift institutions, banks (for their own portfolios and their trust accounts), pension funds, life insurance companies, and private individuals.
GNMAs. Ginnie Maes: pass-through securities, passing homeowners' mortgage payments to investors. They are guaranteed by the Government National Mortgage Association and represent ownership of FHA or VA loans.
PCs. Mortgage participation certificates: pass-through securities guaranteed by the Federal Home Loan Mortgage Corporation. PCs represent interest in conventional (not government-guaranteed) and FHA and VA mortgages.
MBSs. Mortgage-backed securities: about the same as PCs but guaranteed by the Federal National Mortgage Association.
CMOs. Collateralized mortgage obligations, secured by conventional mortgages and issued in bondlike securities with short, intermediate, and long-term maturities.
Warehousing. Whereby lenders borrow capital from other lenders and investors so they have enough money on hand for new loans. The term is also used to describe what a lender does with mortgages until it can sell them on the secondary market; it keeps them in its own portfolio until then.