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   ARTICLE   |   From Scotsman Guide Residential Edition   |   July 2016

Bad Timing Boosts Home-Loan Costs

The secondary market can have a big impact on your client’s mortgage

The cost of implementing the Truth in Lending Act and Real Estate Settlement Procedures Act Integrated Disclosure (TRID) rules has received a lot of attention in the mortgage industry. The new disclosure forms mandated by TRID — the Loan Estimate and Closing Disclosure — have added hundreds of dollars to the cost of producing a loan by some estimates. Additional staff, software upgrades and various process cures are all cited as reasons for the additional cost.

There is another cost that might not be as obvious, however. That cost is realized when prepping a loan for sale in the secondary market. It comes in the form of lost extension fees and the increased hedge costs associated with unforeseen delays in closings. As a mortgage originator, these hidden costs are worth examining and understanding because they can play a role in the trajectory of a loan’s closing.

There have been many discussions about how to account for the delays caused by TRID. Chief among them are concerns over the consequences of charging rate-lock extension fees once the Closing Disclosure form has been issued to the borrower. Changes to that document — which must be issued within three business days of a loan’s closing — prompt another mandatory three-day delay in the loan-closing process. Charging a borrower for a rate-lock extension that will itself create an additional delay only compounds the cost of packaging such a loan for the secondary market.

One way to recover these added costs is to build into a loan’s pricing the assumption that four to five additional days will have to be added to the closing window for a certain percentage of rate locks. In other words, simply increase the margin on the loan to pay for the added fees that will have to be absorbed by the lender in the event a rate-lock extension is needed for some loans after the Closing Disclosure has been delivered. The problem with that approach is projecting how much you can increase the margin before being priced out of the market by the competition.

Rate-lock costs

There are a lot of moving parts that go into calculating the cost to extend a rate lock. For the sake of simplicity, let’s assume that the difference in pricing at the Fannie Mae cash window is the actual cost. Currently that cost is approximately 0.75 basis points per day. For an average loan amount of $200,000, the cost to extend a rate lock would be about $15 per day. That’s not a lot, but it can add up quickly.

TRID-related closing delays that occur at the loan level, however, also can cause additional delays in the sale of loans into the secondary market. This is where the costs are less obvious and can grow at a faster pace. This cost is dependent on a number of factors that will vary depending on the circumstances.

The real issue is whether a lender sells loans to investors on a mandatory basis, or if it delivers loans to the secondary market on a best-efforts basis. Under a mandatory approach, according to Fannie Mae’s execution options, the lender commits to delivering a single loan or multiple mortgage loans at a set price by a specific date. If the lender fails to deliver as agreed, it may be subject to a penalty, known as a pair-off fee. With the best-efforts model, the lender agrees to deliver a single loan, but isn’t charged a pair-off fee unless the loan closes and is not delivered to the investor.

Best efforts

If a best-efforts strategy is used, then the cost to extend a rate lock may likely be a lot more than $15 per day. The typical best-efforts shops create a pad between the rate-lock period on loans and the lock term that they are bound to with the secondary-market investor.

At one time, that pad was as little as a few days. This enabled the lender to offer better loan pricing. The best-efforts shop now has two options in the post-TRID environment.

First, the lender can increase the pad period. If the lender is selling to a big-box aggregator, it probably has a best-efforts loan-delivery commitment option with 15-day increments, so increasing the pad will require moving the loan delivery out another 15 days. This can result in a significant cost to the lender, which has to absorb the added expense of extending the rate lock while it holds the loan.

The second option is to keep the existing pad and pay extension fees to the aggregator as needed. This also can become expensive, and in some cases those extensions might be limited.

At a Glance

The TRID process

TRID stands for The Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA) Integrated Disclosure. The consumer-disclosure regulation took effect this past October and mandates that lenders provide prospective homebuyers with a three-page Loan Estimate form within three business days of receiving a home-loan application. The Loan Estimate includes vital information about the loan, including the estimated interest rate, monthly payment and total closing costs.

TRID also requires that lenders provide borrowers with a five-page Closing Estimate form within three business days prior to the loan’s closing. The Closing Estimate covers the loan terms, closing-cost details and provides a summary of the transaction. If changes to the Closing Estimate are required during the three-day waiting period, the borrower must be provided with a new form and a new three-day window to review the information prior to the loan’s closing.


Mandatory delivery

The best-efforts execution strategy will likely be more costly to the lender overall, compared with the mandatory-delivery option. Still, if a lender does use a mandatory-delivery model, then a delay in loan closings has the potential to wreak havoc on the loan-delivery process. The more sophisticated the lender is in executing such a strategy, the more delays could cause problems, because one loan has the potential to impact the pricing of an entire loan pool.

The most obvious instance where one loan could affect many others is in the case of high-balance limitations in loan pools or securities. For example, a lender’s secondary-market team may have available $4.3 million in loans that can be sold as a pool through the Fannie Mae cash window. That pool, however, includes a $600,000 high-balance loan — which exceeds the 10 percent allowable high-balance concentration.

If an additional $1.7 million in loans become available, and they are not at the high-balance threshold, then the lender will be able to sell the entire pool to Fannie Mae and avoid the price difference for exceeding the high-balance concentration. For this example, assume that the added cost for exceeding the high-balance threshold is 150 basis points. In such a scenario, it appears well worth it to wait a day or two to fill the pool with lower-balance loans and avoid the high-balance pricing.

So the lender’s secondary-market team waits. The next day they get another few loans, and now the pool is up to $5.5 million — just shy of the $6 million target. They need just two more loans to reach that $6 million mark and can see that there are two loans ready to fund the following day, so they decide to wait a bit longer. One of the loans, however, gets delayed, and it looks like it won’t close for three more days. Now the cost to extend for three days is not just 0.75 basis points per day for that one loan, but rather 0.75 basis points for three days on a $6 million loan pool that is now in limbo. The lender’s cost to extend just went from $15 per day to $450 per day.

Is it worth it to wait? The other option is to sell the loans immediately and lose 150 basis points on the $600,000 high-balance loan — or $9,000. So, yes, it is worth waiting for the other loan to close, but at some point it may not be worth the wait. This calculation should be a factor considered by any originator working with a lender that has to decide whether to charge an extension fee that, under the new TRID rules, will delay a loan closing — and the pooling and delivery process as well.

Other factors

Volume is another factor that can affect the loan-delivery process. Larger lenders likely have plenty of inventory to avoid becoming dependent on a single loan closing. The smaller the lender, however, the more amplified the loan-delivery problems become. Originators should keep that in mind when shopping loans, because flexibility in delivering loans to the secondary market can have an effect on a particular lender’s loan strategy.

Another effect of TRID on a lender’s secondary-market strategy is limited to lenders that employ hedging strategies to mitigate risk. Hedge managers select the timing of a hedge based on the rate-lock period and assumed pooling times of their loans. Loans locked for 30 days on March 30 are assumed to close on April 30. There may be a pooling-time assumption of five additional days.

So those loans should be pooled or sold by May 5, at which time the hedge can be removed or paired off. If Fannie Mae mortgage-backed securities are being used as the hedge, the lender would likely sell those securities in May through the forward, or delayed-delivery, market to hedge against interest-rate risk. Assuming that delivery date is set for May 10, if delays occur with some the loans, it could push the pooling date back a day or more.

This would cause the hedge manager to roll the May trade to June, which usually has a variable cost associated with it. Let’s assume that the cost is the bid-ask spread for the security. That can range greatly depending on the security, but even if it is only 3 basis points, the costs can add up.

• • •

There are many things that need to be considered in the overall loan process that can have an effect on the course of a client’s mortgage. As an originator, you can make some assumptions about the nature of a lender’s loan pipeline, for example. The more important goal, however, should be to understand and stay on top of the various factors — both obvious and not-so-obvious — that can affect the loan process. That insight will allow you to adjust your strategies to meet the demands of clients in the ever-changing world in which we live.


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