This category covers establishments primarily engaged in arranging loans for others. These establishments operate mostly on a commission or fee basis and do not ordinarily have any continuing relationship with either borrower or lender.
522310 (Mortgage and Other Loan Brokers)
The loan brokers industry is comprised of firms principally engaged in arranging loans between borrowers and lenders. Such enterprises commonly earn a fee or commission for their services. The industry is dominated by mortgage brokers, though loan agents also arrange miscellaneous business, farm, and personal loans.
Although loan agents and brokers have existed for centuries, the industry received little respect or attention before the 1980s. In fact, as late as the mid-1980s, brokers were relatively insignificant players in the multi-billion dollar mortgage lending business. In the late 1980s and early 1990s, however, several factors combined to propel the industry to unprecedented stature. Low interest rates, a trend toward outsourcing and contracting by financial institutions, and a shift in the structure of U.S. financial markets were the most prominent forces boosting industry success.
Interest rates reached near record lows in the early 2000s, pushing total U.S. mortgage originations over the $2 trillion mark for the first time ever. In 2001, mortgage brokers were originating more than $1 trillion in loans annually. This was equivalent to roughly 55 percent of all mortgages originated in the United States, compared to just 20 percent in 1987. Roughly 30,000 mortgage brokers operated in the United States in the early 2000s, compared to none in the 1970s.
Mortgage loan brokers in the late 1990s began offering a variety of mortgage options for customers, including the adjustable rate (ARM) mortgage (designed to help customers take advantage of low rates but placing the risk on the customers' shoulders should rates suddenly climb) and hybrid or two-step mortgages. Two-step mortgages offered customers an initially low five- to seven-year rate, with the rate then climbing above the market rate. These loans served to let customers borrow with a lower outlay and the hybrid mortgage qualified buyers for more money than under traditional mortgage qualifying means. By the early 2000s, however, many of these options had become less popular due to falling interest rates.
Although loan agents and brokers serve other markets, mortgage loans comprise the vast majority of industry sales. The four-step mortgage lending process includes: originating the loan, which entails approving and selling a mortgage to a customer; funding or underwriting the loan; selling the mortgage in the secondary mortgage market, which supplies lenders with cash to make new loans; and servicing the loan, which involves collection, reporting, and administrative management duties. Most mortgage brokers are concerned only with the first step of the process, mortgage origination. However, some brokers facilitate the buying and selling of mortgages in the secondary market.
A broker, by definition, acts as an intermediary between a buyer and a seller in a transaction. He may represent either party, and he does not take possession of goods or property or deal on his own account. The broker receives a fee or commission from one or both of the parties that is usually based on a percentage of the value of the transaction. Brokers differ from dealers in that dealers are transacting on their own account and may have a vested interest in the transaction. Brokers fill an important marketing need by bringing buyers and sellers together. They also facilitate transactions by providing expertise and advice to buyers and sellers.
The two basic types of mortgage brokers are retail and wholesale. A retail broker, or third party originator (TPO), takes a loan application from a potential buyer and submits it to a lender. The lender reviews the application to determine whether or not to grant the loan. If the lender makes the loan to the applicant, the broker secures a commission, usually between 1 percent and 2 percent of the loan amount. Some lenders also pay a fee to the broker for rejected applications.
Wholesale mortgage brokers represent a smaller segment of the industry. They arrange the purchase and sale of mortgages that have already been originally funded. They help bankers find investors for their mortgages, so that the bank will have money to make new loans, for example. They also solicit retail brokers and mortgage originators that are seeking the most beneficial mortgage terms for their clients.
Mortgage brokers can deliver many benefits to lenders and borrowers. For instance, because brokers are able to efficiently search several institutions to find the best terms, they save time for consumers and help them get the lowest rates and closing costs. In addition, brokers often act as their customers' advocate, walking them through the application process and helping them to avoid delays caused by minor technicalities. Sometimes they are even able to reduce closing costs or waive special fees. Brokers commonly speed up the mortgage process by providing a candid preliminary assessment of what a buyer can afford before the consumer applies for a loan. Brokers are also able to offer several different mortgage options to buyers, whereas individual lenders usually have a more limited selection of lending instruments.
Mortgage brokers benefit the lending industry by providing a more flexible and less costly channel for originating mortgages. Brokers can alleviate a bank's or saving and loan's need to hire and support a sales staff, for instance. By outsourcing their origination activities, banks are able to eliminate many management and administrative costs, education and training expenses, facility expenditures, and salaries and benefits required by an in-house mortgage origination staff. Brokers also allow lenders to geographically diversify their lending operations and to enter and exit different markets very quickly.
Types of Brokers. Most mortgage brokers can be classified into one of four different categories, though "full-service" firms may participate in two or more areas of the business. Traditional mortgage brokers are typically lenders of last resort. Consumers sometimes turn to this type of broker when they are unable to secure a market rate loan through a lending institution. As a result, these agents usually deal with high-risk, high-interest loans, and often participate in the fractionalization of mortgages, meaning that more than one investor is involved with a single mortgage.
Conventional residential mortgage brokers represent 70 to 90 percent of the industry. These professionals work with consumers to secure the best possible loan terms for their particular needs. They represent products offered by the largest financial institutions that are indirectly supported by government sponsored secondary market institutions, such as Fannie Mae and Freddie Mac. Wholesale brokers are also included in this group.
Commercial mortgage brokers arrange loans for nonresidential or multifamily properties. This market differs in that it is not supported by secondary market agencies, and it is not subject to the state and federal regulation imposed to protect residential consumers. Commercial brokerage fees are often three or four times greater than residential mortgage commissions. However, lucrative fees can be elusive because commercial loans are much more difficult to close. Commercial brokers also deal with a wider variety of lenders, including insurance companies, pension funds, and foreign investors.
A fourth sector of the industry is made up of firms that broker government and miscellaneous loans. Federal Housing Administration and Veteran's Administration loans make up most of this market.
Competitive Structure. In 1997, the National Association of Mortgage Brokers (NAMB) boasted a membership of 5,000, one-third the number of total brokers in the country. They also had chapters in 38 states. The industry is difficult to track because many of its participants overlap into other lending, banking, and brokerage activities, and because it was growing very quickly in the early 1990s.
Most brokerage firms are very small shops with between 1 and 10 employees. Some firms have as many as 50 workers. Though they are self-employed, some brokers act as agents, working only for a single lender. Such agents and brokers usually operate on 100 percent commission, but may also receive health benefits or application fees. Other brokerage arrangements include franchise operations that maintain chains of mortgage brokering shops on a regional or national scale.
The industry is regulated primarily through state laws that are designed to protect consumers against fraud and to discourage financial misconduct. Although some states, such as Mississippi, have few constraints, others have more advanced regulatory structures. Florida, for instance, required brokers to take 24 hours of classes on mortgage finance before applying for a license in the early 1990s, and required brokers to disclose all fees that they received. In Illinois, brokers are licensed annually and tested every other year, their loans are spot-checked, they must be bonded, and they must prove a net worth of $25,000. The American Association of Residential Mortgage Regulators (AARMR), which served as a clearing-house for reports of industry fraud in the industry, was trying to encourage more uniform state legislation in the early 1990s.
Mortgage lending in the United States was limited before the 1930s. Savings institutions and life insurance companies were the primary lenders for homebuyers. They often relied on mortgage bankers to originate and service their loans. These lenders typically required a 50 percent down payment on a piece of property, and usually offered a loan term of only five years. Because lenders placed themselves at significant risk in these transactions, they charged high interest rates. As a result, the market for mortgage loans was negligible in the early part of the twentieth century.
The Great Depression, which catapulted large numbers of mortgages into foreclosure and bankrupted many lenders, gave birth to a new lending system in the United States. Realizing the need for a stable and accessible mortgage market, the federal government created the Federal Home Loan Bank (FHLB) system in 1932, the Home Owners Loan Act in 1933, and other programs that sought to reduce the risk of mortgage lending and enforce industry standards. These initiatives, along with FHA and VA programs, served to insure mortgages with government funds and to protect consumers.
The mortgage banking industry flourished in the postwar economic boom. Banks and other financial institutions, which bought many mortgage banking operations, integrated origination and servicing activities into their organizations. As mortgage lending ballooned, the secondary mortgage market evolved as a place for lenders to sell their loans to investors. Wholesale mortgage brokers emerged to unite these investors and lenders.
Although some retail brokers also served the industry in the 1960s and 1970s, loan origination remained an activity provided almost solely by mortgage banks and savings and loans. Loan brokers, in fact, were often viewed as seedy moneylenders that charged excessive fees and rates to arrange loans for problem borrowers. Rather than relying on sound credit analysis, brokers usually protected themselves by insuring that the borrower had a substantial amount of personal equity in a property.
Several developments in the 1980s served to radically alter the mortgage brokering industry, as well as most other U.S. financial services industries. High bond rates and the term structure of interest rates in 1981 caused a massive shift of money from thrift institutions to money market funds. Because they had no money to make loans, mortgage-lending institutions laid off thousands of loan originators to whom they paid salaries. Many displaced originators became self-employed mortgage brokers who worked off commissions or on contract, rather than salary.
In 1982, money market rates plummeted and institutional lenders were again prepared to lend. Rather than hiring new originators, however, many institutions continued to look to brokers to supply their mortgages. As mortgage activity accelerated in the early and mid-1980s, an identifiable, respectable mortgage brokerage emerged to service the origination function. Many brokers expanded their services, and even began franchising their businesses. Savvy lenders, meanwhile, concentrated on underwriting, funding, and service activities, causing many organizations that retained the retail origination function to become less competitive.
Increasing the importance of the mortgage brokers role in the 1980s was the introduction of hundreds of financial instruments that lenders began offering to potential borrowers. Adjustable rate mortgages (ARMs), for example, grew in popularity as hundreds of new ARM options allowed buyers to access a plethora of interest rate structures and payment terms. Before the 1980s, mortgage lenders offered a relatively homogenous product. Borrowers basically had to choose only between government and conventional loans. Inundated with financing options in the 1980s, borrowers began to seek the aid of brokers that could identify the best product for their individual needs.
In addition to increased outsourcing of originations and the development of new mortgage products, a third advancement affected the brokerage industry during the 1980s—the rapid proliferation of new mortgage securities. Among other consequences, these new securities succeeded in luring short- and intermediate-term investors to the market, and in lubricating the flow of money for new loans. Although retail mortgage brokers indirectly benefited from these developments, many traditional wholesale brokers found themselves displaced by securities trading and brokerage firms that sold securitized mortgages on over-the-counter markets.
Although changing financial markets gave birth to a respected mortgage brokering industry in the early and mid-1980s, it was not until the late 1980s and early 1990s that the industry rocketed to prominence. Historically low interest rates, which caused massive mortgage refinancings and spurred new originations, contributed to trends started earlier in the decade and pushed industry revenues to all-time highs.
While brokers originated a negligible share of all mortgages before 1981, by 1988 brokers had captured about 20 percent of the market. By the early 1990s, the industry was selling about 45 percent of the more than $800 billion worth of mortgages originated annually in the United States, resulting in total fees and commissions of between $10 and $14 billion. Some of the most successful individuals were generating as much as $500,000 per year in fees.
Massive growth in the mortgage brokering industry is reflected in NMBA membership growth. Started in 1973, the NMBA had just a few hundred members by 1980. Membership jumped to about 440 by 1988. By 1991, more than 1,200 brokers belonged to the Phoenix organization. Furthermore, the NMBA estimated that about 16,000 companies were providing mortgage-brokering services in the early 1990s that were not association members. Likewise, in 1988 more than 85 percent of all applicants to the Mortgage Bankers Association (MBA) were classified as brokerage companies—up from a minute fraction of that amount in the early 1980s.
Mortgage brokers had grown to dominate entire regions in some areas of the United States. In California, for instance, more than 70 percent of all mortgages were originated by brokers in 1991. "In 1984 there were not five mortgage brokers in the state of New York," said Ralph LoVuolo, Sr., President of LoVuolo & Company, Inc., in Mortgage Banking. "Now there are almost 2,000."
As interest rates continued to fall in the early 1990s, the mortgage brokering industry expanded. Lenders were seeking increasingly faster processing times, high volume, geographic diversity, and lower overhead that they could achieve by outsourcing their origination activities. Consumers were also becoming more comfortable with the concept of using mortgage brokers rather than traditional lending institutions. By 1993, brokers were originating about 50 percent of all U.S. mortgages. The percentage remained the same through 1996, with mortgage brokers originating approximately $405 billion worth of loans.
Though the industry faced few obstacles to continued growth, one imminent threat promised to snuff out massive profit opportunities that characterized the 1980s and early 1990s—rising interest rates. Rates on long-term mortgages dipped below 7 percent in the early 1990s, at the same time that ARMs fell to less than 4 percent. Homeowners subsequently rushed to refinance their mortgages or to buy new homes. By 1994, though—after reaching 30-year lows—interest rates appeared to have stabilized and were even inching back up. In early 1997, the average mortgage rate for a 30-year loan was approximately 8.25 to 8.5 percent, while a 15-year loan was around 7.75 to 8 percent.
Brokers who had been involved in the mortgage industry for long periods of time were well aware of the cyclical nature of the business. In fact, many brokers left other jobs to participate in the industry during the refinancing boom of the late 1980s and early 1990s. Many of those same workers planned to exit or reduce their dependence on the industry as rates climbed. They would go back to real estate appraisal, commercial brokerage, insurance underwriting, or some other job and wait for the next industry upswing.
Despite the expectation of higher interest rates and waning mortgage activity, industry participants were generally optimistic about the future. The recent surge of growth had served to establish respect for brokers. Once viewed suspiciously by most lenders, brokers were now viewed as potentially excellent sources of originations. Even federal secondary marketing organizations, such as Freddie Mac, were buying brokered mortgages in 1997, and extolling the advantages of such purchases. Greater respect and acceptance of brokers by financial institutions meant that brokers would likely increase their share of the mortgage market in the mid- and late 1990s, thereby reducing the negative effects of rising interest rates.
Other factors were also expected to buoy industry earnings during the inevitable down-cycle. One such influence was a lending practice called "warehousing." Warehouse lenders provide loans for other lenders to use to underwrite new mortgages. In 1993, about 25 domestic banks and a dozen foreign banks were making warehouse lines of credit available to mortgage banks and even mortgage brokers. Many more organizations were expected to begin making warehouse loans.
In the long term, the mortgage brokerage industry should proliferate as lenders increasingly outsource their originations. Because the origination business is localized and service-oriented by nature, small mom-and-pop shops will continue to dominate. Companies that under-write, sell, and service the loans that brokers originate, however, will consolidate. Only the largest, most efficient, technologically advanced lenders will remain competitive. Smaller lenders will be consumed by their larger competitors as the industry consolidates. As a result, brokers will supply increasingly fewer lenders in the 1990s and into the twenty-first century.
As the industry matures, brokers can expect to experience greater competition and lower profit margins. Fluctuating interest rates and housing starts, however, will insure periods of high profitability. Increased regulation will also play a role in the industry's evolution.
Fraud and Regulation. While most mortgage brokers in the mid-1990s were legitimate, lax industry regulation contributed to widespread abuse by some brokers. Second-mortgage scandals, particularly, were marring the industry's reputation in the late 1980s and early 1990s. In one type of scheme, for example, dishonest brokers offer to provide home improvement services to prospects. They convince homeowners to take out a second mortgage on their home to pay for the repairs. Besides charging interest rates as high as 20 or 30 percent, the brokers may also deliver shoddy construction. Such brokers typically operate in low-income neighborhoods where their prospects do not have access to normal bank credit. In 1996, California was trying to pass a measure that would regulate these kinds of high-interest, high-fee loans. A federal law went into effect in 1995 that addressed some of the problems. Other scams involve fraudulent documents and embezzlement of lenders' funds.
Broker fraud lawsuits were filed in Alabama, California, Georgia, Virginia, and many other states in the mid-1990s. In 1996, the state of Idaho, for the first time, passed legislation regulating mortgage brokers in an effort to protect consumers. According to FBI and mortgage professionals, 10-15 percent of all loan applications in the mid-1990s involved some kind of fraud.
In an effort to stem fraud and protect the reputation of legitimate operators, several states were scrambling to regulate the fast growing industry. New regulation was aimed at requiring brokers to prove a minimum net worth and to secure bonding. Some states in the mid-1990s were also striving to develop fee limits and to mandate written agreements between brokers and customers. In general, regulators were seeking increased disclosure requirements for borrowers and investors, and stricter licensing requirements.
Many legitimate brokers were wary of what they viewed as federal and state government intrusion. Some observers believed, for example, that a lack of uniformity in state regulations would severely impede the efforts of some lenders to establish national networks of brokers. Other brokers believed that regulation would squelch profits. In 1993, brokers in Illinois, one of the more heavily regulated states, were already spending an average of $4,000 to $8,000 annually on license and audit fees, examinations, and state spot-checking programs. Likewise, brokers in Arizona were required to pass a course, two exams, and post a $10,000 bond before they could operate.
Regulation also occurred at the federal level in the mid-1990s. Fannie Mae, for instance, required participating lenders to spot-check 10 percent of all the mortgages they produced, and revise discretionary samplings of brokered loans. Likewise, the Department of Housing and Urban Development was pressuring the industry to disclose its fees. Other brokers welcomed new regulations as a way to exterminate illegitimate operators.
Mortgage interest rates remained low in the late 1990s and reforms instituted by Freddie Mac and Fannie Mae helped loan brokers offer the customer more for their mortgage loan dollar. In 1999, Freddie Mac created options to lower the cost of mortgage insurance, required for homeowners with less than 20 percent of a down payment for the total mortgage amount. Such reforms could save a customer with a 30-year, $100,000 mortgage anywhere from $1,302 to $2,800. For larger mortgages, loan brokers could offer customers savings of several thousand dollars.
Fannie Mae worked with loan brokers to make mortgages available to underserved customer populations, under the institution's Trillion Dollar Commitment, an endeavor with the goal of "pledging a trillion dollars in housing finance to serve underserved families, and offering lenders cutting-edge mortgage products and technology," according to Fannie Mae CEO and Chairman Franklin D. Raines. Between 1994 and 1999 the initiative targeted $700 billion to fund such mortgages. Fannie Mae worked with the loan brokering industry under the initiative by creating partnerships with lenders and making use of technology to provide flexibility to the lending process.
In the early 2000s, the U.S. Department of Housing and Urban Development proposed several reforms to the Real Estate Settlement Procedures Act (RESPA). The reform most likely to affect the mortgage brokerage industry, if the reforms to RESPA are enacted, is the Guaranteed Mortgage Package (GMP), which requires lenders to give buyers a guaranteed price prior to receiving a purchase commitment. According to the November 2002 issue of Mortgage Banking , GMP presents an opportunity for mortgage brokers mainly because "mortgage brokers have proven time and time again they are the earliest adopters and true innovators of the origination business. If the GMP creates an environment in which originators must aggressively compete by offering the best package, who is likely to be able to compete? The innovative mortgage brokers, who will have both choice and competition on their side."
It is this ability to compete that has propelled the mortgage broker segment to its position in the mortgage industry; mortgage brokers represent the single largest segment of the U.S. home mortgage industry. In 2001, with interest rates lower than they had been since the 1960s, the mortgage industry originated more than $2 trillion in loans for the first time ever. Mortgage brokers handled roughly 55 percent of these loans.
The loan and mortgage brokering industry is highly fragmented. Because of its localized nature, no firms dominate the industry on a national, or even regional, scale. Because most participants are privately held and are not required to publish operating results, little financial data exists about firms within the industry. In 2003, the average brokerage firm operated a single office and used roughly 25 employees to handle a total of 125 loans per year.
Industry leaders include Manhattan Mortgage Co., of New York City, which secured more than $4 billion in loan revenues in 2002 and operated as the top residential mortgage brokerage in the metropolitan New York area. Randall Mortgage, Inc., based in Dublin, Ohio, was ranked the leading residential mortgage brokerage in central Ohio in 2000.
In the mid-1990s Norwest Mortgage Inc. was a leader in mortgage origination, leading competitors with $55 billion in originated loans. Norwest was also the top servicer of residential mortgages (nearly 206,000) for investors. Norwest merged with Wells Fargo in 1998 to become Wells Fargo and Co. Wells Fargo and Co. had 2002 sales of $28.4 billion, reflecting a one-year sales growth of 5.9 percent. The company had net income in 2002 of $5.4 billion. In 2002 retail lending giant Lehman Brothers posted total sales of $16.7 billion with a one-year sales growth of 25 percent, followed closely by rival Credit Suisse First Boston with $13.6 billion in sales.
Although the mortgage brokering industry lacks statistical data that is available for most industries of its size, a study released in 1992 by the NMBA indicated that the average brokerage firm had six employees, had been in business for five years, and had a net worth of $75,000. A NMBA survey released one year later, though, showed that the median broker originated $26 million in mortgages in 1992—a 65 percent increase over 1991.
Many brokers earn in excess of $200,000 or even $500,000 per year, and the average industry income is very high at peak times. Brokers also enjoy independence and flexibility in comparison to many salaried employees. The business has its drawbacks, however. For instance, mortgage brokering is a highly cyclical business. During periods of rising interest rates many brokers experience rapid and significant declines in income levels. In addition to cyclical downturns, brokers usually work long hours and spend many nights and weekends meeting with prospective clients at their convenience.
Also frustrating brokers is the fact that 50 percent of all the loan applications that they assemble for their clients are rejected by banks, resulting in zero fees for the broker. Furthermore, most brokers spend their first few years on the job making cold calls to attorneys, CPAs, and real estate brokers to build a referral base for future business. Finally, mortgage brokering can be very stressful. "You're the primary contingency whether a deal flies or not," said Karen Dell, loan consultant for California-based First Federal in the Los Angeles Business Journal. "People have a lot of money at stake, so their tempers can be short."
Employment prospects for the industry were positive going into the mid-1990s. Besides general growth in the demand for brokers and originators, the demand for support staff should also rise. The Bureau of Labor Statistics estimates that jobs for secretaries and clerical staff in the industry should rise by more than 40 percent between 1990 and 2005. Positions for bill and account collectors should jump by 54 percent. Management support and credit analyst positions should increase by more than 50 percent as well.
The mortgage brokering industry is highly dependent upon modern office technology and, in effect, is a corollary of the information age. There are 0.8 laptop computers per originator in the industry, according to the 1992 NMBA survey, much more than almost any other U.S. industry. Almost all brokers are heavily dependent on fax machines to send and receive loan and credit information. Nearly half of all brokers are part of a computer network, and 13 percent access a computerized loan origination system that lists rates among real estate agents. About four-fifths of all brokers used some form of mortgage processing software in 1993.
In addition to creating an environment which allowed brokers to efficiently originate loans, information technology was also driving increased efficiency of the financial markets, on which mortgage brokers depend to buy their originations and pay their fees. Successful lending institutions were using complex information systems and software to eliminate overhead and reduce administrative costs. Such advances were a driving force behind lender consolidation.
New systems were already being implemented in the mid-1990s that sought to provide a better link between lenders, brokers, real estate agents, and even consumers. New Mortgage Bankers Association of America and American National Standards Institute standards had been developed regarding electronic communications. Countrywide Funding Corp., for example, offered its brokers access to DirectLine Plus, a system that allows brokers to find current data on loans-in-process 24 hours a day. Mortgage companies were moving toward delivering brokers full access to their integrated processing systems.
Advances in technology continued to expedite the mortgage lending process in the late 1990s for lenders and customers. Newly developed software tools such as Desktop Underwriter allowed lenders to use flexibility in evaluating individual loan applications. Fannie Mae CEO Raines estimated that such software increased the amount of low down payment loans that the institute was able to buy, as well as decreasing delinquency among its borrowers.
Loan brokers continued to be served by advances in Internet technology in the late 1990s. In late 1999, IMX(r) Exchange, an online commerce resource for loan brokers, collaborated with Byte Enterprises and Contour Software to improve the efficiency of services available to loan brokers. The collaboration produced the online feature XpressPost(TM), which would allow loan originators to post applications online in real time and receive immediate bids for loans from brokers that were part of the IMX(r) network.
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