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Scotsman Guide Residential Edition | ScotsmanGuide.com | June 2017 54
It can be beneficial for originators to brush up on the interactions between
the primary and secondary mortgage markets. Building a basic foundation
of knowledge about how the secondary market works — and how it affects
the loans they originate — can help originators better serve their borrowers
and Realtor partners, and earn their trust as a valued mortgage expert.
Before addressing the basics of why and how pricing and lock policies
are created — and why they may seem counterintuitive at times — let’s first
take a look at some important definitions.
n Primary Market. This is the origination market for mortgage loans.
Originators, sales assistants and much of a mortgage company’s operations team’s efforts are focused on the primary market.
n Secondary Market. This is the market for the sale of mortgage loans.
The secondary market provides liquidity to the primary market. But, in
doing so, it imposes its own operational considerations and requirements on the primary market. Many mortgage companies and lenders
usually have a separate team dedicated to secondary market operations.
n Liquidity. According to Investopedia, “Liquidity describes the degree
to which an asset or security can be quickly bought or sold without
affecting the asset’s price.” Guidelines standardize loan terms so that
loans can be readily securitized and sold to investors, but the market for
those securities can be subject to liquidity issues at times. Coordination
between the primary and secondary market teams can play a big role in
how liquidity impacts everyone’s bottom line.
What is a loan?
When you originate a mortgage loan, the price to the borrower can be described as the buy price. The sale of that loan to an investor is then the sell
price. This gives an important insight into how mortgage lenders operate:
They see each loan origination is not a single transaction, but two.
In other words, a mortgage loan is bought from a borrower and then sold
in some manner to an investor. Successfully completing both transactions is
paramount to a mortgage company’s ongoing success. It requires teamwork
between primary and secondary areas to maintain loan sales to investors at
the highest level of liquidity possible. Any interruptions will result in some
sacrifice of revenue.
It’s common to think of a loan as a physical thing. Originators often say,
“this is a good loan” and discuss their pipelines as if they are assembly lines
as they strive for accuracy, efficiency and cost controls. Even liquidity issues
consider loans to be like durable goods that can be bought and sold. This
analogy is mostly appropriate, but not entirely.
Loans are not things. They are financing terms and conditions that determine future cashflows from a borrower. Borrowers often understand this
distinction better than originators. They focus on the monthly payments
— the financing — and not the closing table. The collateral, the house, is
obviously a physical object, but that is not what pricing is based on, and
borrowers intuitively understand that.
At any given point in time, investors will determine the value of those
cash flows — the price they will pay to buy a loan — from a present-value
calculation. This is the important point of this distinction because, besides
origination costs, many other factors influence pricing.
Pricing and lock policies
In addition to present-value calculations, there are two loan components
that are priced separately in pricing models. The first is the service fee.
This is usually the first 25 basis points (bps), or 0.25 percent if you prefer,
of the note rate — of the interest cashflow. The rest of the note rate, and all
of the principal cashflow, make up the other piece.
Investors may purchase the whole loan — both pieces combined — or just
the second piece, which is still referred to as the loan but does not include
the service fee. The agencies buy loans this way. When loans are sold using
this latter method, a buyer for the service fee must be found in order to come
up with a whole-loan price. The values for both of these components are
determined by present-value calculations.