In this space I often try to provide a perspective that would be difficult to find published anywhere else, mostly because the subject of mortgage finance just isn’t stimulating enough to attract an audience. For most people, it’s a boring subject that you only really care about 4-6x in your life (when you’re actually getting a mortgage).
There is no pizzaz in talking about where rates are, so to compensate for uninspiring subject matter, my goal sometimes is to shine a light on situations or phenomena within the mortgage industry that doesn’t get talked about. This way, at least there’s a chance that readers might walk away from an article thinking, “Hmmmm… I didn’t know that. That’s kind of interesting.”
It’s a low bar, but even pole vaulters work their way up.
I’m friendly with a loan officer who’ll likely close $250 million in mortgage volume this year. This loan officer is polished and professional, and frankly $250 million in closed loan volume is rarified air in this industry. For perspective, a loan officer that closes even $25 Million in a year is considered a solid producer. Surely, any lender would want to employ a $250 million producer, right?
Most loan officers need to keep their options open, just in case the lender they work for becomes completely unreliable or uncompetitive for a sustained period of time – It happens more often than you’d think. During a hypothetical conversation about how sought after my friend must be within the industry, he told me that at least one prominent lender has told him they wouldn’t hire him because he writes too many jumbo loans.
For the most part, when you hear the word jumbo mortgage, it refers to loan sizes higher than the threshold Fannie Mae and Freddie Mac have set for purchasing loans from banks and mortgage lenders – that threshold in New York City and most of the surrounding area is $822,375. If a client borrows more than that, the lender doesn’t have the option to sell that loan to an entity like Fannie Mae or Freddie Mac where most of the profit comes from. The loan instead goes into the bank’s portfolio and no premium is collected for selling it.
Bottom line, my friend generates less revenue per transaction compared to a loan officer who writes loans that can be easily sold. He’s less profitable, and he would “use up” a significant portion of funds allocated to a bank’s mortgage portfolio. And that’s how an ultra-successful $250 Million producer becomes undesirable in certain circles. It comes down to profitability
I’ve established why conventional loans are more profitable than jumbo loans. But government loans like an FHA or VA mortgage loan are even more profitable than that, sometimes more than twice as profitable. But why?
A Method to the Madness
In my grand effort to continuously chase unique perspectives I thought it might be interesting to get candid answers to industry relevant questions like the one above directly from loan officers. If the subject matter isn’t sexy, at least my method for extracting information could be.
I’m on several text chains with mortgage loan officers spread throughout the industry. None are afraid to express their thoughts and opinions, so just the other day I baited them into a fun conversation hoping to gather creative and candid responses before they knew I’d be using their words for my readers’ entertainment. Of course, I let them all know what I was up to after I completed the exercise and before this piece was published. As expected, I got some really good information along with a healthy smattering of sarcasm and good-natured teasing amongst the participants on the various text chains.
How did I do it?
I sent out the below text (in blue) to get the ball rolling, and then the conversation sort of spiraled from there.
If you were a game show contestant, and the host asked you the following question, how would you respond?
Question: Why are government loans more profitable than conventional loans?
The most technically accurate answer given in the shortest amount of time is the winner.
Here is the first answer I got from a loan officer I’ll call Bear.
They are government insured. That insurance is for the benefit of the lender in case the borrower defaults. so they pose a bit less risk while simultaneously allowing borrowers easier access to homes.
I thought the loan officer was on the right track, but I wasn’t sure if they were specific enough. So, I responded:
But does that explain why they are more profitable? When a mortgage lender sells an FHA loan, they get more money compared to when they sell a conventional loan to Fannie Mae. Why are they more profitable?
It must have been obvious that I wasn’t satisfied with the first answer. It wasn’t specific enough, and perhaps just not entertaining enough. I knew it wouldn’t take long for this crowd’s creativity to surface. Bear decided to provide an in-depth analogy, using the platform to poke fun at a colleague we’ll call Hamster instead of giving me a real answer, although one would eventually come.
The easiest way that I can explain this is via analogy. Think about it like this. When I buy a T-shirt, I’m an XL. When Hamster buys a T-shirt, he is a size small children’s. We’re both paying the same dollar amount for that T-shirt even though mine uses significantly more material. Now translate this into mortgages. My XL T-shirt makes a little less margin because more material is being used. Meanwhile Hamster’s children’s small makes more money and takes less time to make.
I’m not exactly sure what this has to do with FHA loans but I Did enjoy parlaying this into Hamster wearing kids clothes.
Another loan officer called Afghan Hound chimed in with something short and sweet.
Real answer, the market can bare it. Mortgage companies are setting the pricing. Supply and demand.
I wasn’t satisfied with that answer either. I didn’t know if they were taking me seriously or not. My next text response:
I kind of dig the answer about the insurance. There’s a pretty big upfront premium collected, and there’s expensive mortgage insurance that’s paid for as long as somebody has an FHA loan in most instances. That’s a lot of extra money tied to the loan.
My needling finally sparked a debate about the use of FHA loans altogether. At least to me, it became an interesting conversation with opposing viewpoints. As cynical as ever, Bear chimed in again:
Want a real answer? It’s a worse loan positioned as an affordable loan so a borrower can take a higher rate which pays more money.
But in the end after the borrower has paid 1.75 points (aka UFMIP) and lifetime MI (mortgage insurance) which is really just a higher rate dressed up nice, they’re not so affordable other than the cheap (principal and interest) payment.
Clearly Bear was not a huge advocate of the FHA product, which does allow up to 96.5% financing, even for borrowers with lower credit scores and higher debt-to-income ratios compared to most other loan programs with stricter guidelines. In direct contrast to Bear, Afghan Hound was a big proponent of the product and its flexibility:
Ever price out a 633 FICO on conventional with 3% down? Ever look at the cost of mortgage insurance? It’s like double the cost, and good luck getting the automated underwriting system to approve the loan.
In other words, an FHA loan isn’t right for a borrower who has perfect credit and is making a 20% down payment. But certainly, if they had less money saved, and their credit wasn’t as good, the loan program starts to look very attractive, and it can provide options to some borrowers who might otherwise be shut out from buying. Hamster provided a specific example with his own stamp of approval at the end:
I wrote one for a borrower who had a chapter 13 bankruptcy and a 640 FICO score. 2.25% rate. Solid af.
Bear again pointed out that FHA loans do come with low rates, but reminded us that FHA charged a hefty up-front mortgage insurance premium equal to 1.75% of the loan amount:
What would the rate be in a conventional mortgage with a 1.75% buydown?
Hamster reminded Bear that the chapter 13 bankruptcy would likely have made the borrower ineligible for a conventional mortgage, meaning rate and fees were irrelevant. Then pointed out another benefit:
Multi-family homes with 3.5% down payment is magical. A $1M 3-family home with $35,000 down. Write it up. Book it. Close em. And then those clients send 3 more referrals.
Working as part of a real estate team during the last 2 years, our team has not crossed paths with too many clients who used FHA financing to purchase in Manhattan or Brooklyn, in part because getting a building (condo or co-op) approved has been more difficult compared to getting a building approved using conventional financing. Those restrictions however have been recently eased and it’s much easier than before for a building to be compliant with FHA guidelines. I asked the loan officers on the text chain if NYC real estate agents should know more about FHA financing. This is what I asked:
When I helped buyers as a real estate agent in the city, certainly I’ve crossed paths with people who would be able to buy something if they only had to put 3.5% down. So, there is a market for FHA in the city, but I rarely see it used. Do you think it makes sense to get the word out to real estate agents who might now know that there are instances in which an FHA loan does make sense even in Manhattan?
Hamster chimed in right away:
Of course… so many agents have the wrong impression of FHA, in and out of the city. We work on educating agents on agency direct government loans to help them close more business.
10 buyers. 1 or 2 of them may not be able to come up with what to takes to buy using a conventional mortgage.
Then finally, after sitting out the entire conversation, a loan officer I’m calling Puma chimed in in support of FHA:
FHA expands the pool of buyers. I do most of my FHA loans in the boroughs. Mostly multi-family.