What Do Mortgages, Hogs and Oil Have in Common?

Part 8 of the Series: Empowering Homebuyers Through Education

Published in

Own Up

5 min readMay 11, 2016

When most people hear the word, “commodity” they think about things like oil, hogs, wheat or aluminum. Merriam Webster defines a commodity as “a mass produced unspecialized product.” Home loans fit this definition exactly but most lenders don’t want want to acknowledge that loans are a commodity because it diminishes the service they provide.

This is not to suggest that lenders are not service providers, it is just stating that the product they offer (home loans) is the same at every lender. There are a multitude of loan types as we illustrated in a previous article, but in the end, the product is just money that is lent to you so you can buy or refinance your home. And if we agree that home loans meet the definition of a commodity, the primary mechanism to choose between multiple vendors of this commodity should be lowest price (or rate in the case of loans). Like most commodities, closed home loans are sold in a large and active market. In the mortgage industry this market of buyers and sellers is called the secondary market which we will cover in greater detail in a future post.

In residential lending Banks/Credit Unions, Mortgage Lenders and Mortgage Brokers and while they are all offering the same commodity, it is important that you can distinguish between the different service providers. Today, over 90% of consumers seeking a home loan receive it from a bank or mortgage company and the remaining consumers use a mortgage broker to secure their loan.

Banks (Credit Unions)

Banks, and credit unions which function similarly to banks but have a membership requirement, can either be federally or state chartered. The distinction between the two is where they are legally able to lend money. For state chartered banks, they can only lend in states where they have retail branches, whereas federally chartered banks can lend across state lines.

Simply put, banks take deposits from consumers and then use those deposits to lend money to consumers, effectively matching the demand for capital with supply. The bank’s profit is the difference between what they earn on money they lend less what they pay to depositors for the privilege of using their money.

However, most banks that make residential loans only retain a small portion of the loans they issue to consumers. Instead, banks will use their customers’ deposits to fund the loan, but shortly after closing, they sell the loan in the secondary market for a fee. Once the loan is purchased by another institution they return the cash to their balance sheet to be used to fund new loans.

One important thing to note about banks that sell loans in the secondary market is that many will retain the responsibility of servicing of their loans (i.e. sending statements, collecting monthly payments and managing any escrow accounts for taxes and insurance). Banks often retain servicing so they can continue to engage with the customer and they are paid a fee by the the buyer of the loan to perform this service. So if an institution retains the servicing on a loan, the borrower will make their payment to the bank and the bank will then forward those payments to the appropriate buyer of their loan.

Mortgage Companies

Mortgage companies are regulated by each state they do business in and perform a similar primary lending function to banks. However, because mortgage companies cannot legally take deposits, they rely on borrowed capital to provide their loans. Often a mortgage company will maintain a line of credit (called a warehouse line) with a bank and they use these borrowed funds to lend to consumers. Then, once a mortgage company sells their loans, they use the proceeds from this sale to pay down their warehouse line borrowings to free up capital to make new loans.

A mortgage company makes money through both the premiums they receive when selling their loans and also from the difference between the interest rate on the loans they make and the rate charged on their warehouse borrowings. Most mortgage companies do not service their loans so there is a good chance that when a loan is sold, a third party will take over the obligation to collect borrower monthly payments. Also, because mortgage companies do not have the ability to hold loans for long periods of time, they often have more difficulty in making loans that don’t meet secondary market guidelines. Some mortgage companies maintain relationships with other institutions that can make these “portfolio” type loans however it is a function that is generally easier for a bank to perform.

Mortgage Brokers

Prior to the financial crisis, mortgage brokers accounted for almost a third of all mortgages originated in the US. A mortgage broker’s role is to work with a customer, gather enough information to determine their eligibility and to provide a number of potential financing options across multiple lenders.

In theory, they can help assure a consumer is getting a superior product and rate for their particular circumstances because they shop the mortgage among several different lenders. However, some unsavory mortgage brokers lost sight of this role and helped contribute to the financial crisis by placing borrowers in unsuitable loans while collecting fees from both consumers and lenders, a practice which has since been outlawed.

Mortgage brokers represent less than 10% of today’s mortgage market and these institutions do not actually lend money. Like mortgage companies, brokers are regulated at the state level, but they act more as a matchmaker to pair a borrower with a lender, whether that is a bank/credit union or mortgage company. Today’s brokers are paid a fee by the lender that ultimately closes the loan. After the industry’s compensation change that prevented mortgage brokers from getting paid by both lenders and consumers on the same transaction, most brokers exited the business.

So in summary, here are some key concepts to keep in mind when deciding where to get your mortgage:

Banks

Often offer widest selection of loan products given their ability to sell loans or keep in portfolio
Often retain the responsibility of servicing the loan
May try to cross sell other financial products (deposit accounts, credit cards etc.)

Mortgage Companies