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Borrowers Shop the Web
for Mortgages
One business area that has been significantly affected
by the Web is mortgage banking. Historically, bor-
rowers went to local banks, savings and loans, and
mortgage banking companies to obtain mortgage
loans. These offices packaged the loans and resold
them. In recent years, hundreds of new Web-based
mortgage banking companies have emerged.
The mortgage market is well suited to providing
online service for several reasons. First, it is information-
based and no products have to be shipped or invento-
ried. Second, the product (a loan) is homogeneous
across providers. A borrower does not really care who
provides the money as long as it is provided efficiently.
Third, because home buyers tend not to obtain mort-
gage loans very often, they have little loyalty to any
local lender. Finally, online lenders can often offer
loans at lower cost because they can operate with
lower overhead than firms that must greet the public.
The online mortgage market makes it much easier
for borrowers to shop interest rates and terms. By
filling out one application, a borrower can obtain a
number of alternative loan options from various Web
service companies. Borrowers can then select the
option that best suits their requirements.
Online mortgage firms, such as Lending Tree,
have made mortgage lending more competitive. This
may lead to lower rates and better service. It has
also led lenders to offer an often confusing array of
loan alternatives that most borrowers have difficulty
interpreting. This makes comparison shopping more
difficult than simply comparing interest rates.
Borrowers using online services to shop for loans
must be aware that scam artists have found this an
easy way to obtain personal information. They set up
a bogus loan site and offer extremely attractive inter-
est rates to draw in customers. Once they have col-
lected all the information needed to wipe out your
checking, savings, and credit card accounts, they
close their site and open another.
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Part 5 Financial Markets
origination and servicing. They were also able to bundle loans from different
regions together, which helped reduce their risk. The increased competition for
loans among these intermediaries led to lower rates for borrowers.
Securitization of Mortgages
Intermediaries still faced several problems when trying to sell mortgages. The first
was that mortgages are usually too small to be wholesale instruments. The average
new home mortgage loan is now about $250,000. This is far below the $5 million round
lot established for commercial paper, for example. Many institutional investors do not
want to deal in such small denominations.
The second problem with selling mortgages in the secondary market was that they
were not standardized. They have different times to maturity, interest rates, and
contract terms. That makes it difficult to bundle a large number of mortgages together.
Third, mortgage loans are relatively costly to service. Compare the servicing a
mortgage loan requires to that of a corporate bond. The lender must collect monthly
payments, often pay property taxes and insurance premiums, and service reserve
accounts. None of this is required if a bond is purchased.
Finally, mortgages have unknown default risk. Investors in mortgages do not want
to spend a lot of time evaluating the credit of borrowers. These problems inspired the
creation of the mortgage-backed security, also known as a securitized mortgage.
What Is a Mortgage-Backed Security?
By the late 1960s, the secondary market for mortgages was declining, mostly because
fewer veterans were obtaining guaranteed loans. The government reorganized Fannie
Mae and also created two new agencies: the Government National Mortgage Association
(GNMA, or Ginnie Mae) and the Federal Home Loan Mortgage Corporation (FHLMC,
or Freddie Mac). These three agencies were now able to offer new securities backed
by both insured and, for the first time, uninsured mortgages.
An alternative to selling mortgages directly to investors is to create a new secu-
rity backed by (secured by) a large number of mortgages assembled into what is
called a mortgage pool. A trustee, such as a bank or a government agency, holds
the mortgage pool, which serves as collateral for the new security. This process is
called securitization. The most common type of mortgage-backed security is the
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