When you get a mortgage, you may go through your bank or your credit union. These organizations are direct lenders that approve your mortgage in-house and fund it from their own pool of funds. Your bank or credit union may hold your mortgage loan for its life in their portfolio of loans. However, it is more common now for mortgages to be obtained and funded through any number of existing mortgage companies that are correspondent lenders. Then, after closing the loan, they are sold on the secondary mortgage market. This is correspondent lending. Here’s how it works.
Consider working with a financial advisor as you look for a mortgage.
How Does Correspondent Lending Work?
Correspondent lenders originate and fund mortgages. Then these mortgages are sold on the secondary mortgage market to investors. The investor packages the mortgages and sells them as a financial asset called mortgage-backed securities. The correspondent lender from whom you obtained your mortgage loan is turned into a financial intermediary because the investors are essentially lending money to those who obtain mortgages.
Correspondent lending is a key in making sure that money is available in the mortgage market for new mortgages. If your bank loans you the money for a mortgage and then holds that mortgage in their loan portfolio for its life, which may be 30 years, that money is tied up and can’t be loaned to another individual for another mortgage. Correspondent lending serves to make the mortgage market much more liquid.
When the correspondent lender underwrites and funds the mortgage loan, they use their own funds, which is typically a line of credit called a “warehouse line.” That line of credit is repaid after the mortgage loan has been sold on the secondary mortgage market for the funds to be available for the next mortgage.
Correspondent lenders generally sell the mortgages they have originated and funded to an investor like a government-sponsored entity such Fannie Mae and Freddie Mac or to private firms. Correspondent lenders typically tailor their underwriting specifications to the guidelines of the government agency or firm to which they are going to sell the mortgage. These entities repay the correspondent lender the amount of the mortgage, which is often sold to them at a discount. Your correspondent lender will still often service your loan. They will collect the mortgage payments and maintain your escrow account for property taxes and homeowner’s insurance. Between the government-sponsored entities and private firms, many types of mortgages are available through correspondent lenders for a variety of types of real estate properties.
Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac invest in home mortgages. They were developed to provide liquidity in the home mortgage market. They don’t lend money to the public directly. Instead, they serve as a financial intermediary or correspondent lender and guarantee third-party loans. They purchase mortgage loans in the secondary market.
As a government agency, they have implicit backing of the federal government. These government-sponsored entities were developed to provide a more highly liquid mortgage market. They then sell the mortgages to investors packaged as mortgage-backed securities.
Mortgage-Backed Securities
When the investor buys a mortgage or a package of mortgages from the correspondent lender, the investor repackages those mortgages into mortgage-backed securities which are a type of collateralized bond. The mortgage-backed securities are then sold through brokerages where your minimum investment varies. Their rate of return tends to be a little higher than that of Treasury securities due to their different relationship with fluctuating interest rates.
A mortgage-backed security is only as safe as the mortgage which underlies it. If all the parties involved in developing mortgage-backed securities play their individual roles correctly, then mortgage-backed securities are appropriate investments for some investors depending on your investment goals, time horizon and risk preferences.
There are two types of mortgage-backed securities that can be issued. The first are pass-throughs, which are structured as a trust. The second type, collateralized mortgage obligations, are given credit ratings just like bonds which help determine their rates of return.
The Bottom Line
Correspondent lending has become a vital function in our active mortgage market. They make the market more liquid since more mortgage funds are available. Before getting a home mortgage, you need to check around with your bank and correspondent lenders to see where you can find the best mortgage terms.
Tips on Home Buying
- To determine how much of your new mortgage payment will be taxes and homeowner’s insurance if you use an escrow account, check out SmartAsset’s home mortgage calculator.
- In any financial transaction, it’s often best to consult a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Photo credit: ©iStock.com/mediaphotos, ©iStock.com/Wasan Tita, ©iStock.com/jacoblund