Mortgage: Everything you need to know....and more!

What is Loan Origination?

Loan origination is the process by which a borrower applies for a new loan, and a lender processes that application. Origination generally includes all the steps from taking a loan application through disbursal of funds (or declining the application). Loan servicing generally covers everything after disbursing the funds until the loan is fully paid off. Loan origination is a specialized version of new account opening for financial services organizations. Certain people and organizations specialize in loan origination, with mortgage brokers and other mortgage originator companies serving as a prominent example.

There are many different types of loans. For more information on loan types, see the loan and consumer lending articles. Steps involved in originating a loan vary by loan type, various kinds of loan risk, regulator, lender policy, and other factors.

Application Process

Applications for loans may be made through several different channels and the length of the application process, from initial application to funding, means that different organizations may use various channels for customer interactions over time. In general, loan applications may be split into three distinct types:

  • Agent assisted (branch-based)
  • Agent assisted (telephone-based)
  • Broker sale (third-party sales agent)
  • Self-service

Retail loans and mortgages are typically highly competitive products that may not offer a large margin to their providers, but through high volume sales can be highly profitable. The business model of the individual financial institution and the products they offer therefore affects the which application model they will offer

Agent Assisted (Branch-Based) Loan Application

The typical types of financial services organizations offering loans through the face to face channel have a long-term investment in 'brick and mortar' branches. Typically these are:

  • Banks
  • Credit Unions
  • Building Societies

The appeal to customers of the loan offered directly in branches is the often long-standing relationship that a customer may have with the institution, the appearance of trustworthiness this type of institution has, and the perception that holding a larger portfolio of products with a single organization may lead to better terms. From a bank's standpoint, cross-selling products to current customers offers an effective marketing opportunity, and agents in branches may be trained to handle the sale of many different types of financial products.

In a branch, customers typically sit with a sales agent who will assist the customer in completing the application form, selecting appropriate product options (such as payment terms and rates), collecting required documentation (new account opening compliance requirements must be met at this stage), selecting add-on products (such as Payment protection insurance), and eventually signing a completed application.

Dependent on the institution and product being offered, the application may be completed on a paper application form, or directly into an online application through the agent's desktop system. In either case, this phase of application is mostly concerned with the accurate capture of customer's details, and does not incorporate any of the background decisioning work required to assess the suitability of the customer and the risk of default, or the due diligence that must be performed to mitigate risk of fraud and money laundering activities.

A major complexity for the branch origination channel is making the process simple enough that sales agents can be easily trained to handle many different products, while ensuring that the many due diligence and disclosure requirements of the financial and banking regulators regionally are met.

Many back-office functions of loan origination continue from this point and are described in the Processing section below.

Agent Assisted (Telephone-Based) Loan Application

Broker-Sourced (Third Party Sales Agent) Loan Application

Self-service Loan Application

  • Self-service web applications are taken in a variety of ways, and the state of this business has evolved over time
  • Print and fax applications or pre-qualification forms. Some financial institutions still use these.
    • Print, write or type data into the form, send it to the financial institution
    • Form fill on the web, print, and send to the financial institution (not much better)
  • Web forms filled out and saved by the applicant on the web site, that are then sent to or retrieved by (ostensibly securely) the financial institution
  • True web applications with interfaces to a loan origination system on the back end
    • Many of the early solutions had a lot of the same problems as general forms (bad work flows, trying to handle all manner of loan types in one form)
  • Wizard-style applications that are very intuitive and don't ask superfluous questions

Jobs the online application should perform:

  1. Present required disclosures, comply with various lending regulations)
  2. Be compliant with security requirements (such as Multi-Factor Authentication) where applicable.
  3. Collect the necessary applicant data
    1. Exactly what is needed varies by loan type. The application should not ask for data the applicant doesn't absolutely have to provide to get to a prequalification decision for the loan type(s) they seek.
    2. The application should pre-fill demographic data if the applicant is an existing client and has logged in.
  4. Make it easy, quick, and friendly for the applicant (so they actually complete the application and don't abandon)
  5. Get a current credit report
  6. Prequalify (auto-decision) the application and return a real-time response to the applicant. Typically this would be approved subject to stipulations, referred to the financial institution, declined (many FIs shy away from this preferring to refer any application that can't be automatically pre-approved.)

Processing

Decisioning & credit risk

The mortgage business consists of a few people: the borrower, the lender, and sometimes the mortgage broker. The people that originate the loans are usually the mortgage broker or the lender. Depending if the borrower has credit worthiness, then he/she can be qualified for a loan. The norm qualifying FICO score is 620 for SISA/SIVA loans and 600 for Full Doc loans. Depending on what the borrower's credit scores are the lender can assess the risk they may take.

Not only does one's credit score affect their qualification, the fact of the matter also lies in the question, "Can I (the borrower) afford this mortgage?" In most cases the borrower can afford their mortgage. However, some borrowers seek to incorporate their unsecured debt in to their mortgage (secured debt.) They seek to pay off the debt that is outstanding in amount. These debts are called "liabilities," these liabilities are calculated into a ratio that lenders use to calculate risk. This ratio is called the "Debt-to-income ratio" (DTI). If the borrower has excessive debt that he/she wishes to pay off, and that ratio from those debts exceeds a limit of DTI, then the borrower has to either pay off a few debts in a later time and pay off just the outstanding debt. When the borrower refinances his/her loan, they can pay off the remainder of the debt.

Example: if the borrower owes $1,500 in credit cards and makes $3,000 in a month: his DTI ratio would be - 50%. But if the borrower owes $1,500 and makes $2,000 in a month, his DTI ratio would be - 75%. This ratio is seen by many lenders as high and too risky a person to lend to and may or may not be able to afford the mortgage. So that covers qualification, now on to appraising collateral.

Pricing, including Risk-based pricing & Relationship based pricing

Pricing policy varies a great deal. While you probably can't influence the pricing policy of a given financial institution, you can:

  • Shop around
  • Ask for a better rate - some financial institutions will respond to this, some won't
  • Price match - many financial institutions will match a rate for a current customer

Pricing is often done in one of these ways. Follow the internal links for more details:

  • Everyone pays the same rate. This is an older approach, and most financial institutions no longer use this approach because it causes low risk customers to pay a higher than market rate, while high risk customers get a better rate than they might otherwise get, causing the financial institution to get a lower rate of return on the loan than the risk might imply.
  • Risk-based pricing. With this approach, pricing is based on various risk factors including loan to value, credit score, loan term (expected length, usually in months)
  • Relationship based pricing is often used to offer a slightly better rate to customers that have a substantial business relationship with the financial institution. This is often a price improvement offered on top of the otherwise computed rate.

Appraising Collateral

The next step is to have a Real Estate appraiser appraise the borrower's property that he wishes to have the loan against. This is done to prevent fraud of any kind by either the borrower or the mortgage broker. This prevents frauds like "equity striping" and money embezelment. The amount that the appraiser from either the borrower's side or the lender's side is the amount that the borrower can loan up to. This amount is divided by the debt that the borrower wants to pay off plus other disbursments (i.e. cash-out, 1st mortgage, 2nd mortgage, etc) and the appraised value (if a refinance) or purchase price (if a purchase) {which ever amount is lower} and converted into yet another ratio called the Loan to value (LTV) ratio. This ratio determines the type of loan and risk the lender is put up against. For example: if the borrower's house appraises for $415,000 and they wish to refinance for the amount of $373,500 - the LTV ratio would be 90%. The lender also may put a limit to how much the LTV can be - for example, if the borrower's credit is bad, the lender may limit the LTV that the borrower can loan. However, if the borrower's credit is in Good condition, then the lender most likely not put a restriction on the borrower's LTV. LTV for loans may or may not exceed 100% depending on many factors.

The appraisal would take place on location of the borrower's property. The appraiser may take pictures of the house from many angles and will take notes on how the property looks. He/she will type up an appraisal and submit it to the lender or broker (depending on who ordered the appraisal.) The Appraisal is written in the format compliant to FNMA Form 1004. The 1004 is the standard appraisal form used by appraisers nationwide.