US mortgage lending

US mortgage lending model
America has the largest and most developed mortgage lending market in the world, both in terms of organization and the number of financial instruments. The United States was able to occupy a leading position due to the formation of a transparent, liquid secondary market and effective interaction between its participants.

The main participants in the American mortgage market are:

Borrower – purchasing a mortgage loan to purchase a home.
Lender (bank or other lending institution) – providing a loan to the borrower secured by the purchased real estate.
An intermediary is a mortgage agency that raises capital for borrowers and provides liquidity to the market.
Investors (mostly institutional) who purchase mortgage-backed securities.
Primary and secondary mortgage market
Interaction at the borrower-bank level is the primary mortgage market. Its instrument is traditionally a mortgage loan (Mortgage). The most popular types of mortgages in the USA are:

Loan with a fixed interest rate (Fixed-rate Mortgage, FRM).
Loan with a variable interest rate (Adjustable-rate Mortgage, ARM).
For ARM loans, the rate is fixed for an initial period (usually 3, 5 or 10 years), after which the rate becomes variable and is adjusted depending on the market situation. The frequency of interest rate review is determined by the terms of the agreement. Also, according to the agreement, the borrower has the right to early repayment of the loan (Mortgage Prepayment) in any amount at any time.

Typical mortgage loans in the USA are issued in amounts up to $200 thousand on terms of up to 28% PTI and up to 80% LTV, where:

PTI (Payment-to-Income Ratio) – the ratio of the monthly loan payment to the borrower’s monthly income.
LTV (Loan-to-Value Ratio) – the ratio of the loan amount to the market value of the collateral.
A prerequisite for obtaining a mortgage in the USA is insurance of the mortgaged property and title (the risk of loss of ownership of the property). Life and disability insurance is at the borrower's discretion.

Interaction at the bank - intermediary - investor level is the secondary mortgage market. Its instrument is securities issued by mortgage agencies (Mortgage Securities) backed by mortgage loans on the primary market. It is precisely this two-level mortgage lending scheme (Two-level Mortgage) that operates in the USA. Due to the fact that it originated there, it is called the American mortgage model. In practice it looks like this.

Two-tier mortgage lending model
When a borrower applies to a mortgage bank for a loan, the bank enters into an agreement with him and simultaneously requires him to draw up and sign a mortgage note.

Mortgage is a registered security that certifies the rights of the mortgagee and guarantees creditors the receipt of loan payments. If the borrower defaults, funds are returned through the sale of collateral.
Once title to the property is registered, the bank becomes the legal owner of the mortgage. As they accumulate, the bank combines such mortgages into “mortgage pools” and sells them to intermediaries - specialized mortgage agencies. In the US, these are government-supported organizations such as Ginnie Mae, Fannie Mae and Freddie Mac.

Mortgage Pool – a package of homogeneous mortgage loans with similar repayment terms, payments and interest rates.
This is one of the key differences between the American mortgage lending model and the European one. In the United States, lenders do not hold mortgages on their books or issue mortgage-backed securities, but delegate this function to mortgage servicers.

The agencies reimburse the bank for the funds paid to the borrower, and in return receive a stream of future payments from the borrower on the loan, minus the bank's commission. As a result, banks receive money to issue new loans, and intermediaries receive the opportunity to earn money on mortgages.

To do this, mortgage agencies use the rights of claim on mortgages as collateral and issue debt obligations against them - pass-through mortgage backed securities (MBS), also called agency MBS. This process is known as securitization.

Securitization is a mechanism for transforming an illiquid loan (a mortgage that is not an issue-grade security) into a security traded on the exchange and over-the-counter markets.
The agencies sell the issued securities on the stock exchange, transferring to investors who bought the securities a stream of payments from the borrower minus their commission. That is, the agency itself acts as an intermediary, similar to a mortgage bank. At the same time, payments transferred to the investor under MBS are guaranteed not by the real estate collateral, but by the mortgage agency.

Government support for mortgage agencies makes MBS equal in reliability to government bonds. This makes them available to institutional investors who provide liquidity to the secondary mortgage market. Along with conservative investors, the agent Tskie MBS invest their funds and mortgage-backed real estate investment trusts (REITs).