3/13/2017 | Casey Fleming

Do you wonder where the money comes from that you borrow when you get a mortgage?  Does it matter if you understand the industry and know who is the mortgage money source?  If you like understanding what you are doing when you take on the largest debt you’ve ever had, maybe.  But you might be surprised – It’s MUCH more complicated than you think.

Most folks assume that when they get a mortgage from the bank, the bank makes the loan out of the money they hold on deposit (from checking and savings accounts).  Remember “It’s a Wonderful Life?”  Yes, in most people’s minds, it’s like that.  But in reality, it’s not.

The mortgage money source – at the top

Virtually all of the money that makes its way to you when you take out a mortgage comes from institutional investors – large funds that invest billions (or even trillions!) of dollars in many different types of investments.  We will call these investors funds for the sake of clarity.

These funds might be insurance companies, pension funds, mutual funds or even governments.  One of the investments they make is to lend money to hedge funds or government-sponsored enterprises that buy mortgages.   We’ll call these collectively enterprises for clarity.

In this way, the funds become the mortgage money source for the enterprises, moving billions of dollars at a time.  The money that these funds lend to the enterprises is secured by the pools of mortgages they have purchased.  In the same way that you pledge your home as collateral, these enterprises pledge the mortgages as collateral for the billions of dollars they borrow from the institutional funds.

Who are these enterprises that buy mortgages?

You know the big ones.  Fannie Mae and Freddie Mac purchase the vast majority of loans written in the U.S.  Most of the others are purchased by hedge funds controlled by Wall Street Investment banks.  This last category makes all of the “jumbo” and “non-prime” loans written in the U.S.

A very small percentage of loans are not purchased, but – just like in “It’s a Wonderful Life” – are held by the depository institutions that make them.

Who do the enterprises buy mortgage from?

Now we’re getting closer to you, the borrower.  These enterprises and hedge funds purchase mortgages from depository institutions (banks and credit unions – we’ll call them banks for brevity), and from mortgage companies who make or purchase large quantities of mortgages and pool them together to sell to the enterprises.  Collectively we’ll call banks and mortgage companies lenders.

By selling pools of loans to the enterprises, lenders replenish the funds that they use to make mortgages, and the cycle repeats.

Lenders have agreements with the enterprises about how they will underwrite the loans that they assemble into each mortgage pool.  The lender must underwrite your mortgage according to the rules and guidelines defined by the enterprise.  Since almost all loans are sold to Fannie Mae or Freddie Mac, this means every mortgage lender – even banks – are working with the same underwriting guidelines.  Interpretation may vary, but the guidelines do not.

So, the enterprises purchase pools of loans from banks or mortgage companies that make or buy loans underwritten to the guidelines set by the enterprises.  The enterprises thus become the mortgage money source for lenders.

Where do they get their mortgages?

Banks and mortgage companies (we’ll call them lenders for brevity) build their mortgage pools in two ways.

Most lenders have their own loan officers in-house.  We call these retail loan officers.  Like many businesses, lenders always want to expand their reach to build their business.  They can rent more offices, hire managers, hire administrative assistants and processors, buy desks. chairs, computers, phones and office supplies, and then hire loan officers and tell them to go out and sell loans.

Or they can outsource.

Lenders contract with mortgage brokers to take on the risk, absorb the cost and originate loans for them.  They agree to pay the brokers the money they would otherwise spend expanding and managing their own infrastructure.  So, brokers are paid by the lender, not you, and the mortgage money source for brokers is the lenders, or mortgage companies and banks.

Lenders pass on the underwriting guidelines from the enterprises, and the brokers originate and process the loans, but turn them over to the lender for underwriting.  The lender underwrites the loan to make sure it meets the enterprises’ guidelines, and funds the loan once it’s approved.

You may not know if you’re dealing with a mortgage company or a mortgage broker.  Many actually operate as both a broker and a lender, depending on the loan.  In the long run it doesn’t matter – your loan will be underwritten to the same guidelines and funded from the same pool no matter who you choose.

Back to the top…

So what is the ultimate mortgage money source?

Where do the institutional investors get their  money?

If you have an IRA or 401K and invest in a balanced portfolio fund or a bond fund, some of your money is probably in those funds.  If you have a life insurance policy, some of your money is definitely in those funds.  If you are a citizen of a country that invests in those funds through their central bank, your tax dollars go into those funds.

In other words, you are the mortgage money source.  But between you and you, there are a lot of middlemen.

And the important point is…

No matter where you get your mortgage, the mortgage money source is almost always the same and goes through middlemen who have to compete for space in the channel.  So, despite advertising to the contrary, no lender has a magic source of money.  It just isn’t there.

Casey Fleming is the author of The Loan Guide: How to Get the Best Possible Mortgage and a mortgage advisor in Silicon Valley