Understanding how mortgages are financed

Ken Stone

Saturday, August 25, 2007

With very few exceptions, when lenders fund mortgages they are not looking to make their money back on a monthly basis. This is true even with large mortgage banks that fund a loan with their own money and retain servicing rights - the right to collect your monthly payment.

Instead, mortgage companies fund loans with their money (really a line of credit issued by an investment bank or other source) with the ultimate intention that this money will be securitized and sold as mortgage-backed securities (mortgage bonds) to the investment community. The securitizing of mortgages is the first step in the mechanism by which mortgage money is constantly refreshed into the marketplace.

The problem today is that, basically, anything other than conforming or government-sponsored mortgage bonds (FannieMae, Freddie Mac or Ginnie Mae) have all but gone away.

The reason for this is the market for securitizing other than conforming/government pools of mortgage money essentially has seized. While there are consumers who would take out these loans to buy homes - and lenders who would like to make the loans - there are no investors willing to buy the mortgage bonds because their perceived value has dropped so significantly there's no way to effectively price them. For example, if you made a loan for $100, then turned around and sold your $100 loan to someone else for $101, that would be a good thing. But what if the $100 you lent now sells for $75 or $50 or even $15 because of the perceived risk that the loan you made will never be repaid?

What about your existing mortgage, you might ask. What happens if the company collecting your mortgage payment goes out of business? You won't be affected. Servicing rights can be bought and sold - and frequently are. The value of those rights may be diminished based on the current unhappy news, but there's still value associated with them. Your mortgage won't be forgiven if the servicer is out of business.

So, what to do? If you're thinking about buying a home, do yourself a favor: Find the home, put it under contract and close as quickly as possible. Why? The volatility in the credit markets means that loan availability and rates are changing all the time. You don't want to be stuck with a home you can't purchase because the loan you thought was available no longer is.

I would also recommend working with a mortgage originator who understands what the markets are doing and who has reputable sources of money available. The originator who understands the markets and looks out for the clients' best interests will make the difference between a pleasant mortgage experience and the nightmare that becomes family lore.

Ken Stone is a registered mortgage adviser who helps clients make the most of residential real estate through strategic mortgage planning. His practice has been based in Fort Collins for nearly a decade. He can be reached at StoneTeam@ctxmort.com.