How Lenders Create Loan Products for Customers
You know one of the mysteries associated with this business is how do lenders come up with
loan products to offer to their customers. How can one lender offer a similar product with a 660 credit score minimum and another with a 640 credit score minimum even though the same income and liabilities are used to make the underwriting decisions. You know how many loans I could not do because my company didn’t have a broker relation with a certain wholesaler. Is this pure randomness that they choose to do so or is their something else going on!
My guess was some mathematical genius sitting in a tower who sifts through credit scores and averages on what people make and look for historical correlation of default rates within these parameters.
After speaking to some colleagues of mine about this topic I started gain some real insight about how lenders create loan products to offer to customers either through brokers or direct to the consumer. Alot of what my colleagues had to say was associated with what the secondary market or the companies or wall street that will buy from them and what motivates them to create their loan product after doing further research.
First let me explain how lenders operate and make money. When I say lender I am referring to the sub prime or non prime mortgage companies and lenders who offer their customers loan terms and products that fit outside of the conventional Fannie Mae loan standards of 80 Loan to Value and 20 percent down. Most lenders make money by selling their loans to the secondary market who sells it again it bulk in the form of bulk mortgage back securities.
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They take all of their loans to Wall Street to move them on the secondary market and the products that they offer are often dictated by what they can sell and what price they can sell it at. Different investors have different tolerances for potential losses. The bigger the risk, the bigger the potential reward
Let’s say 3 different mortgage companies sell to an investor. Each mortgage company picks and chooses where they want to make the completion.
The guy on the Street says that he will buy 90% loan to value type loans with a 100% Combined Loan To Value at a 620 score stated with no more than a 50% Debt To Income.
He also says if you have a 640, he’ll give you 5 more basis points. If the loans the lender offers the investor has the applicants who have confirmed seasoned assets, He’ll give the lender an extra 50 basis points toward the spread. If your Debt To Income Ratio is below 45%, he’ll give you an extra 15 basis points etc.
Lender A might do it at a 620 score and make no extra, but make it with a 45% Debt To Income. Lender B will allow you to do the 50% DTI, but he wants the 640 FICO.
Lender C investor takes 12 months. bank statements at a minimum, but if you give him 24, you’ll get an extra 45 basis points Gain on Sale…. etc…
So the incentive they get from their investment determines what products they offer to customers
Each lender makes up their own rules that fall within the investing guidelines, they type up rate sheets, train underwriters, and grab cell phone salesmen to be their AEs to push their product.
The product guidelines a lender comes up with are all actuarial in nature and based on statistics of risk of the loan going bad. If a 10 years of history tells the bank that stated loans with a score below 600 foreclose 25% of the time and scores above 600 only foreclose 10% of the time where would you set your guideline?
There are some lenders who hold their paper and service it themselves so they can come up with virtually whatever product they want to because it is their exposure and if the loans don’t perform they are the one’s stuck with it.
I am referring to the sub prime or non prime mortgage companies and lenders.
In come to my attention that there are only 10 major sub prime players in the secondary market. But how many sub prime lenders are there in the primary market? I’ll just say as of late its over 560. However these guys sell to the same people, these lenders just twist their guidelines in order to make the projected gain on sale that they want to make.
Remember lenders make money not on the transaction but on the return on money made over time.
