The Mortgage World and the Corona Virus

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The Corona virus pandemic is decreasing the capital mortgage lenders require to make new loans. Depending on how long this continues, it could have dire consequences. Dire as in as bad as the 2008 mortgage meltdown, maybe worse.

The World of Mortgages Overview

A borrower gets a mortgage loan, which, upon closing is managed by a servicing company (which quite often is not the company that originated the loan). The servicer collects monthly payments, pays taxes, insurance, sends payments to the investor answers questions. The servicer does not own the loan; the investor does. The investors usually sell the loans to aggregators or to Fannie Mae or Freddie Mac. Those entities place the loan together with a bunch of other loans, and the bunch ends up with a investment banker who converts the loans into mortgage-backed securities. The mortgage-backed securities are sold to mutual funds, pension funds, insurance plans, that is to say, to me and you, the public.

Mortgage Servicer

Servicers pay an upfront fee to get the right to service a loan. They get paid a monthly fee for servicing. It takes about 3 years of monthly fees for them to break even. Quite often, the upfront fee is paid with the help of a loan. Usually up to 50% of that fee. That way they can buy the right to service more loans at the same time.

Servicer’s Dream

When interest rates drop, borrowers want to refinance. If they refinance before the loan is 3 years old, the servicer loses money. If they refinance after 3 years, the servicer makes money. The longer after the 3 year mark they refinance, the more money the servicer makes. So, servicers’s ideal world is a world where rates never drop.

Servicer’s and Normal Refinancing Cycles

The thing about rates dropping? Servicers lose loans to refinancing, but buying goes up, so they end up with new loans, which compensate, at least in part, the loss from refinancing. This and the portion that end up in foreclosure is accounted for in the fee they receive.

Servicers and The Corona Virus

The Corona virus shut down a lot of businesses, which means a lot of people don’t have incomes and, therefore, cannot pay their mortgages. The Government stepped in to help and lenders are placing mortgage loans in forbearance. But it has done nothing for servicers; they must send investors all the monthly payments amounts, even for the loans whose borrowers have not made their monthly payments.

The monthly fee they receive from the loans that are still getting paid is not enough to cover their loss (the pricing accounted only for typical losses due to refinancing and foreclosures.

So, servicers are not in a good place. Which makes them not willing to purchase servicing rights, which means servicing right prices go down.

Lenders and the Corona Virus

In addition, when mortgage payments are not made the first month, they are not desired, investors don’t want them. That means, they remain the responsibility of the lender that made them. Which means that lenders cannot acquire the cash they need to fund new loans.

Lenders and the Corona Virus and The FED

When a borrower locks a rate for, say 30%, the lender is promising a particular rate for 30 days, even if rates go higher. Rate changes during the lock period can cost lenders money (rates are based on the price of mortgage-backed securities; when their price goes higher, rates go down and vice versa).

If mortgage-backed securities cost less (as they do due to the Corona Virus issues), interest rates go higher. Which means that lenders have to buy down all their locked rates. Not a good idea to a lender. So lenders bet, they short mortgage-backed securities. So, the loss from rates going up is offset by the money they make betting mortgage–backed security prices go down.

If rates go down, the lenders can close loans at lower rates, making lenders money. However that money is offset by the losses they have from shorting mortgage-backed securities.

So, when the market functions normally (not too much swing), lenders don’t lose while being able to give borrowers the promised rates.

But that is not the situation these days. These days, the FED’s wanting to make sure rates are low means it’s been buying lots and lots of mortgage-backed securities, raising their prices. A lot and fast. That caused loses on the shorting side of things.

These loses could be offset by future closings. Except that the margins must be paid now, not in the future.

Which has made many a lender stop making the riskier loans (non-QM) while others tightened the restrictions so they are making much fewer. Many shortened the period they are willing to guarantee locks.

In addition, the type of loans they are still willing to make have issues. Social distancing makes it harder to close loans; there’s a large number of loan applications that were started for borrowers who, suddenly, do not have jobs, so the closings will not happen.

And that’s where it is today.