Saturday, March 8, 2008

Types and characteristics of mortgage companies

Mortgage bankers, mortgage brokers, or mortgage companies are primarily representatives of the ultimate sources of money, such as life insurance companies, savings banks, trust or pension funds, or private parties. They are essentially money brokers who may or may not service the loans they originate. These entities are not thrift institutions, nor are they depository institutions, but they do assist by bringing the borrower together with a lender and charge a fee for this service.

Types of mortgage companies

Investment bankers – Investment bankers make a market for both new and seasoned mortgage–backed securities. These firms, called securities dealers, buy and sell securities from lenders and investors. Mortgage bankers, savings banks, pension funds, insurance companies, and mutual funds generally conduct their secondary market transactions with investment bankers.

Mortgage loan brokers are in the business of locating borrowers and lenders, and arranging loans between them. As such the loan broker takes no risk of loss. Another distinction between a mortgage banker and a mortgage (or loan) broker is that mortgage bankers service the loans of the lenders that they represent, whereas loan brokers usually do not. Mortgage bankers differ from mortgage brokers in that the former generally are not third parties to a loan. They generally fund the loan with their own funds.

Mortgage bankers are generally incorporated businesses that can make loans with their own funds or through a line of credit. The mortgage banker originates, finances "funds", and closes loans secured by real estate and sells them to Institutional investors for whom the loans are thereafter serviced. While at times a mortgage banker might act in a broker capacity, particularly if the loan is for an amount beyond the capacity of the mortgage banker to fund, this would be the exception rather than the rule.

Noninstitutional lenders

Many of the loans made by mortgage bankers are made for particular investors such as other lenders and pension plans. They will make the loans to meet the lending criteria desired by these particular investors. Much of their activities deal with out–of-state lenders and investors who desire to make long–term loans secured by California real estate. Because of the size of our real estate market, California mortgage bankers can assemble packages of trust deeds of significant value. Mortgage Correspondent – When a mortgage banking company represents a life insurance company, bank, thrift association, pension fund, or other lender, it is called a mortgage correspondent. It "corresponds" on behalf of its principals in dealing with prospective borrowers. The mortgage correspondent is paid a fee in exchange for originating, processing, closing, and servicing loans. The firm may be given exclusive territories, in which case the correspondent will be entitled to a fee, even if it had not actively solicited the loan; or it may be nonexclusive, in which case the correspondent is in effect in competition with the lenders that it represents. Whatever the type of arrangement, loan correspondents serve a very valuable function in real estate financing for lenders whose headquarters or principal offices are located great distances from the properties on which they make loans. Correspondents have been especially successful in the Far West, particularly in California. Although most mortgage companies act as correspondents in investing others' funds, there are many firms that invest their own funds exclusively. Another category of mortgage lender is a hybrid, both investing money into real estate trust deeds and mortgages for others in an agency or fiduciary capacity, and its own funds in the role of a principal.

Characteristics of mortgage companies

Type of institution – Brokerage.

Mortgage companies do not take deposits, but finance their operations through short–term bank loans, their own capital, and fees from sales and servicing. They routinely sell nearly all the loans they originate, and are minor holders of mortgage debt.

In California, mortgage companies are licensed by the Department of Corporations, and they are subject to lending and other general business regulations.

Mortgage companies may also engage in a number of related real estate activities. These include brokerage, development, construction, and property management. This is especially true when activity in the mortgage market slows down.


A syndicate is an organization of investors pooling capital for real estate investment. Syndicates can take the form of a corporation, a full partnership or, the most popular, a limited partnership. A typical syndicate combines the money of the individual investors with the management expertise of a sponsor, known as the general partner, and follows a three step cycle: acquisition, operation and disposition.

In California, the Department of Corporations regulates control of syndicates. Under the Corporation's Code, real estate brokers may engage in the sale of real estate syndicate security interests without obtaining a special broker–dealer license. However, all such sales must be made under strict adherence to the full disclosure provisions of the California Uniform Partnership Act. In addition, the California Corporations Code, Section 15507, states that a limited partner may become liable for the total debts of the partnership if the limited partner takes an active role in management.

Syndicates are considered to be investment conduits that pass profits and losses to investors in proportion to their ownership shares. Any tax liabilities are imposed at the investor's level. Intrinsic in the design is the investors' liability for debts of the partnership, which are usually limited to their investment. The income from these syndicates, or limited partnerships, is considered passive by the IRS.

In the 90's, a new form of business organization, a limited liability company, or "LLC," was introduced which combines the single–level tax benefit of a partnership with the organizational structure and limited liability of limited partnerships and corporations. Members of an LLC can participate in running the organization without becoming personally liable for business obligations.

In California, an "articles of organization" form must be filed with the Secretary of State to establish an LLC. The LLC format may incur higher fees and taxes than general or limited partnerships.

Corporate bonds are credit instruments used to raise long–term funds. When these bonds are backed by a mortgage on specifically described real estate.

Real estate investment trusts

Real Estate Investment Trusts (REITs) are trusts, owned by shareholders who can exchange their shares on the open market. REITs provide a means by which relatively small investors can participate in large–scale real estate investments. REITs are very heavily invested directly in real estate.

REIT is a creature of the federal tax law. It was created in 1960 with the goal of encouraging small investors to pool their resources with others in order to raise venture capital for real estate transactions. It has been called the "mutual fund" of the real estate business. Just as mutual funds invest in a diversified portfolio of corporate stocks and bonds, REITs invest in a diversified portfolio of real estate and mortgage investments, with a large number of investors who combine or pool their funds. REITs are conduits for investment income only. They are organized under state law as unincorporated associations managed by trustees. They are creatures of federal tax law which permits their distributions to shareholders to be nontaxable to the trust, so long as certain requirements are met. They provide a means by which relatively small investors can participate in large–scale real estate investments.

Requirements – Briefly, at least 90% of ordinary income must be distributed to shareholders; more than 75% of assets must be real estate and more than 75% of income must come from such investments; there must be 100 or more shareholders with no fewer than six owning more than half the trust; the trust may not hold property for sale to customers in the ordinary course of business or provide services to tenants except through independent contractors.

Tax treatment – REITs are tax–exempt only on the income passed through, and shareholders must pay personal income tax on that. Passthroughs of depreciation may offset ordinary income and passthroughs of capital gains do receive capital gains treatment. Under the Tax Reform Act of 1986, profits and losses are classified as "passive" income, putting limitations on the deductibility of ordinary losses.

During the economic crisis of the 1970s, many REITs folded under the pressures of poor management, excessive speculation, withdrawal and cancellation of take–out commitments, terminations of bank lines of credit, poor credit analysis, excess building in many parts of the country (particularly in the condominium market and in recreational projects), and sagging demand.

In the 1980s, to restore confidence in the REIT, concessions worked out between REITs and the banking and securities industry slowly revived REITs. This slow revival continued until the late 1990s, when a hot stock market put a damper on REITs. By 2001, the stock market declined and some money began to flow back into REITs.

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