Loan origination
Encyclopedia
Loan origination is the process by which a borrower applies for a new loan
, and a lender processes that application. Origination generally includes all the steps from taking a loan application through disbursal of funds (or declining the application). Loan servicing
generally covers everything after disbursing the funds until the loan is fully paid off. Loan origination is a specialized version of new account opening for financial services organizations. Certain people and organizations specialize in loan origination, with mortgage broker
s and other mortgage originator companies serving as a prominent example. A Loan Origination Fee Is Often required and this is one of the legal / approved fee required of borrowers mostly by UK lenders. No other fee is expected from the borrower a Borrower has paid for this fee because it covers the originating and conclusion of the loan application.
There are many different types of loans. For more information on loan types, see the loan
and consumer lending articles. Steps involved in originating a loan vary by loan type, various kinds of loan risk, regulator, lender policy, and other factors.
Retail loans and mortgages are typically highly competitive products that may not offer a large margin to their providers, but through high volume sales can be highly profitable. The business model of the individual financial institution and the products they offer therefore affects on which application model they will offer
organizations offering loans through the face to face channel have a long-term investment in 'brick and mortar' branches. Typically these are:
The appeal to customers of the loan offered directly in branches is the often long-standing relationship that a customer may have with the institution, the appearance of trustworthiness this type of institution has, and the perception that holding a larger portfolio of products with a single organization may lead to better terms. From a bank's standpoint, cross-selling products to current customers offers an effective marketing opportunity, and agents in branches may be trained to handle the sale of many different types of financial products.
In a branch, customers typically sit with a sales agent who will assist the customer in completing the application form, selecting appropriate product options (such as payment terms and rates), collecting required documentation (new account opening compliance requirements must be met at this stage), selecting add-on products (such as Payment protection insurance
), and eventually signing a completed application.
Dependent on the institution and product being offered, the application may be completed on a paper application form, or directly into an online application through the agent's desktop system. In either case, this phase of application is mostly concerned with the accurate capture of customer's details, and does not incorporate any of the background decisioning work required to assess the suitability of the customer and the risk of default, or the due diligence that must be performed to mitigate risk of fraud and money laundering activities.
A major complexity for the branch origination channel is making the process simple enough that sales agents can be easily trained to handle many different products, while ensuring that the many due diligence and disclosure requirements of the financial and banking regulators regionally are met.
Many back-office functions of loan origination continue from this point and are described in the Processing section below.
Jobs the online application should perform:
Decisioning & credit risk
The mortgage
business consists of a few people: the borrower, the lender, and sometimes the mortgage broker
. The people that originate the loans are usually the mortgage broker or the lender. Depending if the borrower has credit worthiness, then he/she can be qualified for a loan. The norm qualifying FICO
score is not a static number. Lender guidelines and mitigating factors determine this number. Recent changes in the market and industry have made stated income and stated asset loans a thing of the past and full income and asset documentation is now required from the majority of Fannie Mae and Freddie Mac back mortgage securities.
Not only does one's credit score affect their qualification, the fact of the matter also lies in the question, "Can I (the borrower) afford this mortgage?" In most cases the borrower can afford their mortgage. However, some borrowers seek to incorporate their unsecured debt in to their mortgage (secured debt.) They seek to pay off the debt that is outstanding in amount. These debts are called "liabilities," these liabilities are calculated into a ratio that lenders use to calculate risk. This ratio is called the "Debt-to-income ratio
" (DTI). If the borrower has excessive debt that he/she wishes to pay off, and that ratio from those debts exceeds a limit of DTI, then the borrower has to either pay off a few debts in a later time and pay off just the outstanding debt. When the borrower refinances his/her loan, they can pay off the remainder of the debt.
Example: if the borrower owes $1,500 in credit cards and makes $3,000 in a month: his DTI ratio would be - 50%. But if the borrower owes $1,500 and makes $2,000 in a month, his DTI ratio would be - 75%. This ratio is seen by many lenders as high and too risky a person to lend to and may or may not be able to afford the mortgage.
So that covers qualification, now on to appraising collateral.
Pricing is often done in one of these ways. Follow the internal links for more details:
The following sections describe the specific requirements of loans and mortgages.
appraiser
appraise the borrower's property that he wishes to have the loan against. This is done to prevent fraud of any kind by either the borrower or the mortgage broker. This prevents frauds like "equity striping" and money embezelment. The amount that the appraiser from either the borrower's side or the lender's side is the amount that the borrower can loan up to. This amount is divided by the debt that the borrower wants to pay off plus other disbursments (i.e. cash-out, 1st mortgage, 2nd mortgage, etc) and the appraised value (if a refinance) or purchase price (if a purchase) {which ever amount is lower} and converted into yet another ratio called the Loan to value
(LTV) ratio. This ratio determines the type of loan and risk the lender is put up against.
For example: if the borrower's house appraises for $415,000 and they wish to refinance for the amount of $373,500 - the LTV ratio would be 90%. The lender also may put a limit to how much the LTV can be - for example, if the borrower's credit is bad, the lender may limit the LTV that the borrower can loan. However, if the borrower's credit is in Good condition, then the lender most likely not put a restriction on the borrower's LTV. LTV for loans may or may not exceed 100% depending on many factors.
The appraisal would take place on location of the borrower's property. The appraiser may take pictures of the house from many angles and will take notes on how the property looks. He/she will type up an appraisal and submit it to the lender or broker (depending on who ordered the appraisal.) The Appraisal is written in the format compliant to FNMA Form 1004. The 1004 is the standard appraisal form used by appraisers nationwide.
.
Other related topics include:
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
, and a lender processes that application. Origination generally includes all the steps from taking a loan application through disbursal of funds (or declining the application). Loan servicing
Loan servicing
Loan servicing is the process by which a mortgage bank or subservicing firm collects the timely payment of interest and principal from borrowers...
generally covers everything after disbursing the funds until the loan is fully paid off. Loan origination is a specialized version of new account opening for financial services organizations. Certain people and organizations specialize in loan origination, with mortgage broker
Mortgage broker
A mortgage broker acts as an intermediary whose brokers mortgage loans on behalf of individuals or businesses.Traditionally, banks and other lending institutions have sold their own products. However as markets for mortgages have become more competitive, the role of the mortgage broker has become...
s and other mortgage originator companies serving as a prominent example. A Loan Origination Fee Is Often required and this is one of the legal / approved fee required of borrowers mostly by UK lenders. No other fee is expected from the borrower a Borrower has paid for this fee because it covers the originating and conclusion of the loan application.
There are many different types of loans. For more information on loan types, see the loan
Loan
A loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
and consumer lending articles. Steps involved in originating a loan vary by loan type, various kinds of loan risk, regulator, lender policy, and other factors.
Application Process
Applications for loans may be made through several different channels and the length of the application process, from initial application to funding, means that different organizations may use various channels for customer interactions over time. In general, loan applications may be split into three distinct types:- Agent assisted (branch-based)
- Agent assisted (telephone-based)
- Broker sale (third-party sales agent)
- Self-service
Retail loans and mortgages are typically highly competitive products that may not offer a large margin to their providers, but through high volume sales can be highly profitable. The business model of the individual financial institution and the products they offer therefore affects on which application model they will offer
Agent Assisted (Branch-Based) Loan Application
The typical types of financial servicesFinancial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...
organizations offering loans through the face to face channel have a long-term investment in 'brick and mortar' branches. Typically these are:
- BankBankA bank is a financial institution that serves as a financial intermediary. The term "bank" may refer to one of several related types of entities:...
s - Credit UnionCredit unionA credit union is a cooperative financial institution that is owned and controlled by its members and operated for the purpose of promoting thrift, providing credit at competitive rates, and providing other financial services to its members...
s - Building SocietiesBuilding societyA building society is a financial institution owned by its members as a mutual organization. Building societies offer banking and related financial services, especially mortgage lending. These institutions are found in the United Kingdom and several other countries.The term "building society"...
The appeal to customers of the loan offered directly in branches is the often long-standing relationship that a customer may have with the institution, the appearance of trustworthiness this type of institution has, and the perception that holding a larger portfolio of products with a single organization may lead to better terms. From a bank's standpoint, cross-selling products to current customers offers an effective marketing opportunity, and agents in branches may be trained to handle the sale of many different types of financial products.
In a branch, customers typically sit with a sales agent who will assist the customer in completing the application form, selecting appropriate product options (such as payment terms and rates), collecting required documentation (new account opening compliance requirements must be met at this stage), selecting add-on products (such as Payment protection insurance
Payment protection insurance
Payment protection insurance, is an insurance product that is often designed to cover a debt that is currently outstanding Payment protection insurance, (also known as PPI, credit protection insurance, loan repayment insurance, not to be confused with income protection or credit card cover) is an...
), and eventually signing a completed application.
Dependent on the institution and product being offered, the application may be completed on a paper application form, or directly into an online application through the agent's desktop system. In either case, this phase of application is mostly concerned with the accurate capture of customer's details, and does not incorporate any of the background decisioning work required to assess the suitability of the customer and the risk of default, or the due diligence that must be performed to mitigate risk of fraud and money laundering activities.
A major complexity for the branch origination channel is making the process simple enough that sales agents can be easily trained to handle many different products, while ensuring that the many due diligence and disclosure requirements of the financial and banking regulators regionally are met.
Many back-office functions of loan origination continue from this point and are described in the Processing section below.
Self-service Loan Application
- Self-service web applications are taken in a variety of ways, and the state of this business has evolved over time
- Print and fax applications or pre-qualification forms. Some financial institutions still use these.
- Print, write or type data into the form, send it to the financial institution
- Form fill on the web, print, and send to the financial institution (not much better)
- Web forms filled out and saved by the applicant on the web site, that are then sent to or retrieved by (ostensibly securely) the financial institution
- True web applications with interfaces to a loan origination system on the back end
- Many of the early solutions had a lot of the same problems as general forms (bad work flows, trying to handle all manner of loan types in one form)
- Wizard-style applications that are very intuitive and don't ask superfluous questions
Jobs the online application should perform:
- Present required disclosures, comply with various lending regulations)
- Be compliant with security requirements (such as Multi-Factor AuthenticationTwo-factor authenticationTwo-factor authentication is an approach to authentication which requires the presentation of two different kinds of evidence that someone is who they say they are. It is a part of the broader family of multi-factor authentication, which is a defense in depth approach to security...
) where applicable. - Collect the necessary applicant data
- Exactly what is needed varies by loan type. The application should not ask for data the applicant doesn't absolutely have to provide to get to a prequalification decision for the loan type(s) they seek.
- The application should pre-fill demographic data if the applicant is an existing client and has logged in.
- Make it easy, quick, and friendly for the applicant (so they actually complete the application and don't abandon)
- Get a current credit report
- Prequalify (auto-decision) the application and return a quick response to the applicant. Typically this would be approved subject to stipulations, referred to the financial institution, declined (many FIs shy away from this preferring to refer any application that can't be automatically pre-approved.)
Decisioning & credit riskCredit riskCredit risk is an investor's risk of loss arising from a borrower who does not make payments as promised. Such an event is called a default. Other terms for credit risk are default risk and counterparty risk....
The mortgageMortgage loan
A mortgage loan is a loan secured by real property through the use of a mortgage note which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan...
business consists of a few people: the borrower, the lender, and sometimes the mortgage broker
Mortgage broker
A mortgage broker acts as an intermediary whose brokers mortgage loans on behalf of individuals or businesses.Traditionally, banks and other lending institutions have sold their own products. However as markets for mortgages have become more competitive, the role of the mortgage broker has become...
. The people that originate the loans are usually the mortgage broker or the lender. Depending if the borrower has credit worthiness, then he/she can be qualified for a loan. The norm qualifying FICO
Fico
Fico may refer to:* Fair Isaac Corporation , an American company* FICO score, a credit score developed by Fair Isaac Corporation * Hurricane Fico, a hurricane in the 1978 Pacific hurricane season...
score is not a static number. Lender guidelines and mitigating factors determine this number. Recent changes in the market and industry have made stated income and stated asset loans a thing of the past and full income and asset documentation is now required from the majority of Fannie Mae and Freddie Mac back mortgage securities.
Not only does one's credit score affect their qualification, the fact of the matter also lies in the question, "Can I (the borrower) afford this mortgage?" In most cases the borrower can afford their mortgage. However, some borrowers seek to incorporate their unsecured debt in to their mortgage (secured debt.) They seek to pay off the debt that is outstanding in amount. These debts are called "liabilities," these liabilities are calculated into a ratio that lenders use to calculate risk. This ratio is called the "Debt-to-income ratio
Debt-to-income ratio
A debt-to-income ratio is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts. A debt-to-income ratio (often abbreviated DTI) is the...
" (DTI). If the borrower has excessive debt that he/she wishes to pay off, and that ratio from those debts exceeds a limit of DTI, then the borrower has to either pay off a few debts in a later time and pay off just the outstanding debt. When the borrower refinances his/her loan, they can pay off the remainder of the debt.
Example: if the borrower owes $1,500 in credit cards and makes $3,000 in a month: his DTI ratio would be - 50%. But if the borrower owes $1,500 and makes $2,000 in a month, his DTI ratio would be - 75%. This ratio is seen by many lenders as high and too risky a person to lend to and may or may not be able to afford the mortgage.
So that covers qualification, now on to appraising collateral.
Pricing, including Risk-based pricing & Relationship based pricing
Pricing policy varies a great deal. While you probably can't influence the pricing policy of a given financial institution, you can:- Shop around
- Ask for a better rate - some financial institutions will respond to this, some won't
- Price match - many financial institutions will match a rate for a current customer
Pricing is often done in one of these ways. Follow the internal links for more details:
- Everyone pays the same rate. This is an older approach, and most financial institutions no longer use this approach because it causes low risk customers to pay a higher than market rate, while high risk customers get a better rate than they might otherwise get, causing the financial institution to get a lower rate of return on the loan than the risk might imply.
- Risk-based pricingRisk-based pricingRisk-based pricing is a methodology adopted by many lenders in the mortgage and financial services industries. It has been in use for many years as lenders try to measure loan risk in terms of interest rates and other fees...
. With this approach, pricing is based on various risk factors including loan to valueLoan to valueThe loan-to-value ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.Loan to value is one of the key risk...
, credit scoreCredit scoreA credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person...
, loan term (expected length, usually in months) - Relationship based pricingRelationship based pricingRelationship Based Pricing is a new concept that is emerging in the banking industry. RBP is essentially a pricing and billing framework that helps banks cut through their product silos and enable customer centric pricing...
is often used to offer a slightly better rate to customers that have a substantial business relationship with the financial institution. This is often a price improvement offered on top of the otherwise computed rate.
Loan Specific Compliance Requirements
Many of the customer identification and due diligence requirements of loan origination are common to new account opening of other financial products.The following sections describe the specific requirements of loans and mortgages.
Cross Selling, Add-on Selling
- Add-on Credit InsuranceCredit insuranceCredit insurance is a term used to describe both business credit insurance and consumer credit insurance, e.g., credit life insurance, credit disability insurance Credit insurance is a term used to describe both business credit insurance (a.k.a. trade credit insurance) and consumer credit...
& debt cancellation - Credit cross sellingCross-sellingCross-selling is the action or practice of selling among or between established clients, markets, traders, etc. or the action or practice of selling an additional product or service to an existing customer. This article deals exclusively with the latter meaning. In practice, businesses define...
- Up-sellingUp-sellingUpselling is a sales technique whereby a seller induces the customer to purchase more expensive items, upgrades, or other add-ons in an attempt to make a more profitable sale. Upselling usually involves marketing more profitable services or products but can also be simply exposing the customer to...
- Down-selling
- RefinancingRefinancingRefinancing may refer to the replacement of an existing debt obligation with a debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as, inherent risk, projected risk, political...
- Loan Recapture
Appraising Collateral
The next step is to have a Real EstateReal estate
In general use, esp. North American, 'real estate' is taken to mean "Property consisting of land and the buildings on it, along with its natural resources such as crops, minerals, or water; immovable property of this nature; an interest vested in this; an item of real property; buildings or...
appraiser
Appraiser
An appraiser , is one who sets a value upon property, real or personal. In England the business of an appraiser is usually combined with that of an auctioneer, while the word itself has a similar meaning to that of "valuer." In the United States, the most common usage relates to real estate...
appraise the borrower's property that he wishes to have the loan against. This is done to prevent fraud of any kind by either the borrower or the mortgage broker. This prevents frauds like "equity striping" and money embezelment. The amount that the appraiser from either the borrower's side or the lender's side is the amount that the borrower can loan up to. This amount is divided by the debt that the borrower wants to pay off plus other disbursments (i.e. cash-out, 1st mortgage, 2nd mortgage, etc) and the appraised value (if a refinance) or purchase price (if a purchase) {which ever amount is lower} and converted into yet another ratio called the Loan to value
Loan to value
The loan-to-value ratio expresses the amount of a first mortgage lien as a percentage of the total appraised value of real property. For instance, if a borrower borrows $130,000 to purchase a house worth $150,000, the LTV ratio is $130,000/$150,000 or 87%.Loan to value is one of the key risk...
(LTV) ratio. This ratio determines the type of loan and risk the lender is put up against.
For example: if the borrower's house appraises for $415,000 and they wish to refinance for the amount of $373,500 - the LTV ratio would be 90%. The lender also may put a limit to how much the LTV can be - for example, if the borrower's credit is bad, the lender may limit the LTV that the borrower can loan. However, if the borrower's credit is in Good condition, then the lender most likely not put a restriction on the borrower's LTV. LTV for loans may or may not exceed 100% depending on many factors.
The appraisal would take place on location of the borrower's property. The appraiser may take pictures of the house from many angles and will take notes on how the property looks. He/she will type up an appraisal and submit it to the lender or broker (depending on who ordered the appraisal.) The Appraisal is written in the format compliant to FNMA Form 1004. The 1004 is the standard appraisal form used by appraisers nationwide.
Mortgage Underwriting
An underwriter is a person who evaluates the loan documentation and determines whether or not the loan complies with the guidelines of the particular mortgage program. It is the underwriter's responsibility to assess the risk of the loan and decide to approve or decline the loan. A processor is the one who gathers and submits the loan documents to the underwriter. Underwriters take at least 48 hours to underwrite the loan and after the borrower signs the package it takes 24 hours for a processor to process the documents.Regulation
Lending is a highly regulated business, at both the Federal and State levels. Some of the main regulations that apply to lending are listed here. For more details, see Bank regulationBank regulation
Bank regulations are a form of government regulation which subject banks to certain requirements, restrictions and guidelines. This regulatory structure creates transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things...
.
- Truth in lending actTruth in Lending ActThe Truth in Lending Act of 1968 is United States federal law designed to promote the informed use of consumer credit, by requiring disclosures about its terms and cost to standardize the manner in which costs associated with borrowing are calculated and disclosed...
(aka Regulation Z) - Equal Credit Opportunity ActEqual Credit Opportunity ActThe Equal Credit Opportunity Act is a United States law , enacted in 1974, that makes it unlawful for any creditor to discriminate against any applicant, with respect to any aspect of a credit transaction, on the basis of race, color, religion, national origin, sex, marital status, or age ; to the...
(aka Regulation B) - Home Mortgage Disclosure ActHome Mortgage Disclosure ActThe United States Home Mortgage Disclosure Act was passed in 1975. It requires financial institutions to maintain and annually disclose data about home purchases, home purchase pre-approvals, home improvement, and refinance applications involving 1 to 4 unit and multifamily dwellings...
(HMDA)
Other related topics include:
- Predatory lendingPredatory lendingPredatory lending describes unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly...
- UsuryUsuryUsury Originally, when the charging of interest was still banned by Christian churches, usury simply meant the charging of interest at any rate . In countries where the charging of interest became acceptable, the term came to be used for interest above the rate allowed by law...
- Loan sharking
See also
- Loan servicingLoan servicingLoan servicing is the process by which a mortgage bank or subservicing firm collects the timely payment of interest and principal from borrowers...
- Making payments
- Credit bureauCredit bureauA credit bureau , or credit reference agency is a company that collects information from various sources and provides consumer credit information on individual consumers for a variety of uses. It is an organization providing information on individuals' borrowing and bill paying habits...
reporting - Loan defaultDefault (finance)In finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, e.g. has not made a scheduled payment, or has violated a loan covenant of the debt contract. A default is the failure to pay back a loan. Default may occur if the debtor is either...
- CollateralCollateral (finance)In lending agreements, collateral is a borrower's pledge of specific property to a lender, to secure repayment of a loan.The collateral serves as protection for a lender against a borrower's default - that is, any borrower failing to pay the principal and interest under the terms of a loan obligation...
RepossessionRepossessionRepossession is generally used to refer to a financial institution taking back an object that was either used as collateral or rented or leased in a transaction. Repossession is a "self-help" type of action in which the party having right of ownership of the property in question takes the property...
& remarketing
- Loan types are covered to a degree in the LoanLoanA loan is a type of debt. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower....
article - e-Lending