How the Mortgage Industry Works
Not only is buying a home the largest single purchase most families make, it is also one of the most complicated. That is why the average homebuyer depends on a network of housing professionals to help guide him through this cumbersome process. Real estate companies, loan originators, loan underwriters, appraisal firms, primary lenders and secondary mortgage institutions: all have a stake in the selling and financing of the nation's homes and each plays a crucial role in the success of home energy rating/energy mortgage programs. Understanding how the mortgage industry works is essential to the design and implementation of a successful home energy rating program.
HOUSING INDUSTRY PRIORITIES
First, it is important to realize that saving energy is not the primary concern to the industry. For the most part, priorities can be view as:
- Homebuilder: building a home the buyer is willing to pay for
- Real estate agent: market a home for the quickest possible sale
- Lender: make money by financing the purchase in as secure a manner as possible
- Appraiser: to determine market value of the home
Home energy rating systems and energy mortgages can bridge all of these interests while fostering an increased demand for energy efficiency from consumers.
When buying a house, most consumers will turn to their real estate agent or loan originator first to help them find a suitable property and advise them about financing options. Many times, it is through these two sources that the idea of a home energy rating or an energy mortgage is brought up.
- Both real estate agents and loan originators are paid on a commission basis, therefore although adding energy efficiency into a mortgage increases their potential earning, the energy rating and energy mortgage must be quick and easy to achieve since volume and a fast turnaround time are vital for their business.
What is a primary lender? The local bank, credit union or financial institution that has direct contact with the community is the primary lender. For example, if you got your mortgage through your local bank, they would be your primary lender.
SECONDARY MORTGAGE MARKETS
Due to the large volumes of sales required by the mortgage industry (to minimize risk of default), primary lenders work with major financing sources known as the secondary mortgage market to access the funds necessary to finance home loans throughout the nation.
The secondary mortgage market:
- Buys and sells mortgage loans in large lots on a national basis
- By handling mortgages in huge quantities, and hence reducing risk, the secondary mortgage markets can offer competitive benefits such as lower interest rates while still making targeted profit margins
- Primary lenders can offer their borrowers a broad menu of mortgage options by taking advantage of programs offered by the secondary mortgage market
As the underwriter for most of the country's mortgage loans, the secondary mortgage market is where energy mortgages must be initiated. Primary lenders will not sell energy mortgages, unless they know the secondary mortgage market is a willing partner in the process.
Fortunately, both the government and secondary components of the secondary mortgage market recognize the benefits of creating and supporting programs, which allow the financing of residential energy efficiency features through the mortgage loan. However, homebuyers in states without home energy rating systems, which are recognized and accepted by the secondary mortgage market, rarely qualify for energy mortgage programs.
TOOLS TO ADD VALUE FOR EFFICIENCY
The way it works:
- After the loan originator initiates a loan, the primary lender uses a loan underwriter and an appraiser to ensure the borrower meet market risk criteria.
- The loan underwriter certifies the borrower has met the necessary credit qualification for the applicable secondary mortgage market program. The debt-to-income ratio stretch feature of an energy mortgage allows an underwriter greater flexibility in qualifying a borrower to purchase an energy efficient home.
- The appraiser evaluates the value of the property and compares it with similar houses in the neighborhood. A lender can only finance a portion of the home's market value. The market value of the home must be high enough to assure the primary and secondary lenders that their institutions will not lose money if the lender forecloses and the property is repossessed. If the appraisal does not place value on a feature of a home, it cannot be financed, and the buyer must pay the added costs out of pocket, thus increasing the down payment. Because of this, an appraiser bases the appraised value on the home's market value and not price.
WHERE A HOME ENERGY RATING COMES IN
A home energy rating system is the answer! A rating presents data about a home's efficiency in terms and facets that both the industry and consumers can understand. Rating information can be added to and easily tracked through the MLS and appraisal database. The rating gives appraisers the data they need to add value for increased efficiency.
- Rating system information is now integral to the Alaska housing market and is included in a house’s listing information and the state’s appraisal institute database.
- Colorado and Rhode Island also include rating information in their MLS, while other states are following suit.
- Because of this market data, appraisers routinely add a higher value for rated homes.
However, even with the quantitative measurement provided by a home energy rating, energy efficiency may continue to be appraised conservatively until enough data is collected to demonstrate the added value stands up when the energy efficient home is resold.
There are a couple of ways to help expedite this process:
- Educate the appraisal industry about how the rating system works and how the appraiser can use the energy rating to add or subtract value
- Create a transition period during which a home energy rating system can capitalize the energy efficiency above the appraised value. Fannie Mae, Freddie Mac and FHA all allow this through the form 70A addendum to the standard appraisal form. However, this form is seldom used.
By its very complexity, the mortgage market challenges the introduction of new ideas and concepts. Each tier of the professional network must be educated about the benefits of energy mortgages to both their industry and their clients before energy mortgages become institutionalized. The adoption of a common method of measuring the relative energy efficiency of a home - the home energy rating system - is the first, vital step to meeting that goal.
When it comes to a residential mortgage, what many people don’t know is that there is something called the secondary mortgage market....
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