Quiz 11: Sources of Funds for Residential Mortgages

Business

The goal of the Financial Institutions Reform, Recovery, and Enforcement Act is to charge banks and thrifts for risky lending practices and to reward safer practices. It supplanted the conventional regulatory approach of simply attempting to prohibit risky behavior even though banks and thrifts found the risk-taking profitable.

We are asked to choose the appropriate solution from the given options for the statement: Mortgage banking companies ___________________. The correct response is " option A". Collect monthly payments and forward them to the mortgage investor. Explanation: A Mortgage bank specializes in originating and/or servicing mortgage loans. Mortgage banks frequently use the secondary market to sell loans because the funds received pay down their warehouse lines of credit which enables the mortgage bank to continue to lend. A mortgage bank is not regulated as a federal or state bank and does not take deposits from consumers or businesses. A mortgage bank raises some equity which it uses to guarantee the warehouse line and the bulk of the funds are provided by the warehouse lender.

A forward commitment is a commitment now to sell/buy something in the future at a price set now. The commitment is mandatory; that is, the parties must complete the transaction. A standby forward commitment is the same arrangement except that one party, usually the seller, has the option of completing the transaction (delivering) or abandoning the contract. Mortgage bankers use forward commitments to hedge against price changes on loans. This commitment obligates the secondary market investor to purchase, and the mortgage banker to sell, a pre-specified dollar amount of a certain type of loan. It is used for loans that are sure to be originated. Standby forward commitments hedge price changes for loans that may or may not be originated. Standby forward commitments from secondary market investors give lenders the right, but not the obligation, to sell a certain dollar amount of a certain loan type to the issuer of the standby commitment.