02 Apr How the Real Estate Lending Markets Work
A man once said: The real estate business is not about real estate – it is about finance. He was right. One of the biggest hangups for people in real estate investing is not knowing how to finance their real estate and not knowing how loans work. I want to help you understand how a loan application flows to avoid this hang-up.
A lot of people don’t know this, but in the early 1990’s the mortgage industry and the ability of the investor (or average consumer) to get loans dramatically changed. The mortgage industry went to computerized lending. And they elevated the importance of the FICO credit score, which had just come out. That made the real estate market much more liquid than it had been in the previous 100 years. Since then, three phases have developed in the loan process.
Retailing Lending Market: This is where the lending market, mortgage bankers, mortgage brokers, and banks intersects with the retail borrower—i.e. home buyer or multi property (1-4 units) investor. The way this works is that we go to one of these three places to apply for a loan. The lenders underwrite the loan where we make applications according to certain criteria. The lenders that make these loans pool them together and sell them to the secondary lending market. These loans must meet certain underwriting guidelines in order to be sold to the secondary market.
Occasionally you’ll find a lender that will hold loans within their portfolio, called portfolio lending. Local banks will do this with you if you set up a good relationship with them so that they don’t have to be concerned with the criteria.
Secondary Lending Market: This is where the quasi-government mortgage banks of Fannie Mae and Freddie Mac and a number of large private sector mortgage banks purchase these loans—typically in pools of a million dollars and up. They then repackage them in larger pools and sell them to investors in the equities market. So the retail lending market is where you and I interface primarily with getting our loans done. Then the secondary lending market is buying them and repackaging them.
Equities Lending Market: This is where pension funds, insurance companies, mutual funds, foreign investors, and state governments come in. They purchase these pools or packages of loans and they package them as mortgage securities, just like you would stock or similar things. That’s why we call it the equities lending market.
This is what keeps the mortgage lending industry liquid. For the foreseeable future, even out 50 years from now (in my opinion) the lending market is going to be very liquid for real estate. Since the early 1990’s, the underwriting system for most loans is now computerized which makes getting approved for a loan much easier.
Let me know the questions you might have about Lending in the comment section!
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