If you’re a mortgage lender, having a steady revenue stream is essential if you want to remain competitive in the real estate market. However, the mortgage industry can be extremely risky due to fluctuating interest rates and other market factors, which can cause loans to fall out. This can happen in what is called the mortgage pipeline. To ensure everything goes smoothly, you need to effectively manage mortgage pipeline risk to keep money flowing. To help you get started, take a look at these three steps you should take to effectively manage mortgage pipeline risk.
What is the mortgage pipeline?
The mortgage pipeline refers to mortgage loans that are locked in with mortgage originators, which are typically mortgage brokers or mortgage bankers. The mortgage originator’s mortgage pipeline is managed by its secondary marketing department, which manages where their home loans and servicing rights are bought and sold between investors and lenders. The secondary market is where mortgages are bought and sold and packaged into mortgage-backed securities and sold to investors in different forms, such as hedge funds and pension funds.
The loans within an originator’s mortgage pipeline are often hedged to mitigate fallout risk. In order to manage mortgage pipeline risk, it’s essential to take precautionary measures, which we’ll discuss in the second below.
3 steps for managing mortgage pipeline risk
Most mortgage institutions and originators group their mortgages together and sell them to a purchasing agent, such as Fannie Mae or Freddie Mac, which places them in the secondary market. The time between the mortgage being entered on the lender’s books and its sale to the borrow is referred to as the mortgage pipeline. To manage your mortgage pipeline to offset risk and increase efficiency, follow these three steps:
1. Manage your mortgage pipeline for a secondary sale
The first step to managing mortgage pipeline risk is to manage your mortgage pipeline for a secondary sale, which is when you grant a homebuyer a mortgage to buy a home. When a borrower takes out a mortgage, they lock in a current interest rate, which is when the loan enters the lender’s mortgage pipeline. However, if mortgage rates fall, borrowers have the right to choose a new lender without a penalty.
This isn’t great for lenders, though. Loan commitments are firm for lenders, which means they can be left with a hefty portfolio and risky loan commitments that can result in a fallout or price fluctuations. This is where efficiency mortgage pipeline management comes in handy, which is done through forward-sale commitments and hedging the pipeline.
2. Forward-sale commitments
A forward sale commitment is an agreement to carry out a transaction sometime in the future and articulates the specifics of the mortgage loan, such as the price, rates, and date delivered. This mandatory commitment by the originator must explain these details, and if the originator fails their commitment, the agent can charge a pair-off fee. The originator can make a “best-effort” commitment that isn’t subject to a pair-off fee should they fail to deliver. However, this can come with some serious markups that can make the price of the home loan less favorable.
3. Mortgage hedge
If the mortgage originator experiences a pipeline fallout where a commitment doesn’t close, which was discussed earlier, they can reduce the volatility of the mortgage pipeline to boost profitability with a mortgage hedge. This can be beneficial if a forward-selling commitment comes with a large sticker price. To create a successful hedging program, it’s important to include these three steps:
- Maintain your models and keep accurate data, which can help eliminate human error and boost efficiency when it comes to making the right hedging decisions.
- Estimate the probability of pipeline fallout, which can help contribute to hedge tracking error and understand the impact of each pipeline stage, interest rate movements, and borrower characteristics.
- Calculate the hedge dollar amount, which can allow originators to protect themselves should the price decline and the hedge position’s value rises.
Following these three steps for hedging with market capital interest can help you manage mortgage pipeline risk.
Whether you’re a retail bank, mortgage broker, or mortgage lender, it’s essential to manage your mortgage pipeline risk to prevent losing out on a sale in the event a borrower decides to choose another lender. With these three steps to manage mortgage pipeline risk, you’ll be able to reduce the risk of your pipeline’s volatility.