Warehouse line of credit
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A warehouse line of credit is a credit line used by mortgage bankers. It is a short-term revolving credit facility extended by a financial institution to a mortgage loan originator for the funding of mortgage loans.
The cycle starts with the mortgage banker taking a loan application from the property buyer. Then the loan originator secures an investor (often a large institutional bank) to whom the loan will be sold, whether directly or through a securitization. This decision is generally based on an institutional investor's published rates for various types of mortgage loans, while the selection of a warehouse lender for a particular loan may vary based on the types of loan products allowed by the warehouse provider or investors in the loan approved by the warehouse lender to be on the line of credit.
After an investor has been selected, the mortgage banker draws on the warehouse line of credit to fund a mortgage and sends the loan documentation to the warehouse credit-providing institution to act as a collateral for the line of credit. The warehouse lender, at this stage, perfects a security interest in the mortgage note to serve as collateral. When the loan is finally sold to a permanent investor, the line of credit is paid off by wired funds from this permanent investor to the warehouse facility and the cycle starts all over again for the next loan.
Typical durations that loans are held on the warehouse line, called dwell time, range based on the speed at which investors review mortgage loans for purchase after their submission by mortgage banks. In practice, this length of time is generally between 10-20 days. Warehouse facilities typically limit the amount of dwell time a loan can be on the warehouse line. For loans going over dwell, mortgage bankers are often forced to buy these notes off the line with their own cash in anticipation of a potential problem with the note.
Warehouse lines of credit play an important role in making mortgage loan market more accessible to property buyers since many mortgage bankers would not be able to attract sufficient amount of deposits that are necessary to fund mortgage loans by themselves. Therefore, warehouse funding allows the loan originators to provide mortgages at more competitive rates. Unlike in other types of lending, loan originators earn more profit from origination fees rather than interest rate spread since the closed mortgage loan is sold quickly to an investor.
The warehouse funding providing institution accepts various types of mortgage collateral, including subprime and equity loans, residential or commercial, including specialty property types. The warehouse lenders in most cases provide the loan for a period of fifteen to sixty days. Warehouse lines of credit are usually priced off 1-month LIBOR plus a spread. Also warehouse lenders typically apply a 'haircut' to credit line advances meaning that only 98% - 99% of the face amount of loans are being funded by them; the originating lenders have to provide with the remainder from their own capital.
Reasons for using a warehouse line of credit include:
- Permanent Funding: Mortgage lender does not have to draw deposits - the line of credit provides permanent funding for the life of all loans in the program.
- Less Risk: No margin calls - once the asset is funded, there is no additional mark-to-market and posting of collateral.
- Unlimited Loan Volume: Warehouse line of credit program can fund an unlimited loan volume. This enables specialty lenders to enlarge their portfolios for maximum interest income and eliminates the need to manage multiple sources of capital.
In addition, in this way the warehouse credit institution can manage an exposure to mortgage loans market without building a branch network of its own.
Warehouse lending can be differentiated between 'wet funding' and 'dry funding'. The difference is related to when the loan originator gets his funds with respect to the time at which the real estate transaction takes place. During 'wet funding' the mortgage loan provider gets the funds at the same time as the loan is closed, i.e. before the loan documentation is sent to the warehouse credit provider. 'Dry funding' takes place when the warehouse credit provider gets the loan documentation for review before sending the funds.
An important aspect of the warehouse credit providing business is limiting fraud on warehouse lending. Main risks of fraud include dishonest and collusive mortgage loan originators, title companies, real estate agents and customers themselves, false information in the loan application (especially appraisals), forged signatures on the loan documents, and false documents of title. The 'Wet funding' type of warehouse credit is riskier in terms of possible fraud because the credit provider will not be aware of any potential problems until after the funds are sent to the loan originator. Measures that the warehouse lender can take to limit fraud can be a strong screening process for mortgage brokers and mortgage banking companies, making sure the loan originator itself has a strong internal screening process, limiting the amount available for 'wet funding', and having separate account for funds coming from sale of loans to investors.
- International Finance Corporation - Warehouse Line of Credit
- Colorado Mortgage Lender's Association - http://cmla.com/mortgageterms
- Armstrong, C. L.; McNeill, T. H.; Reynolds, J. E. (2006): "Warehouse Lending Losses Under the Financial Institution Bond", The Fidelity Law Journal, Vol. 12.
- Key Features of Warehouse Lines
- Fraud in Warehouse Mortgage lending
- Schroeder, G. J.; Tomaine, J. J. (2007): Loan Loss Coverage Under Financial Institution Bonds, page 336. Chicago: ABA Publishing.