The Squeeze: How Independent Mortgage Bankers Can Survive Margin Compression

By Shannon Faries, Director of Strategic Relationships, Land Gorilla


The last year was a difficult one to predict, and no one expected the residential mortgage refi boom to last for so long, nor the high volume and sustained demand of home buyers who have altered their buying patterns. And yet, Gain on Sale is dropping for Independent Mortgage Bankers. Volume is up and profits are down.  Margin compression is rearing its ugly head. And nearly 70% of lenders believe profit margins will decrease in the third quarter of 2021. Perhaps the current state of events can be summed up in the first line from Charles Dickens’,  A Tale of Two Cities:  “It was the best of times, it was the worst of times…” 

In this article, we will discuss the things that are going great for IMBs, and what to do about the things that aren’t so great, like combating margin compression. Surviving margin compression will get you through this next swing in the market, and if you are willing to put in the work and resources, you have the opportunity not only to survive, but to thrive. 


The Best of Times for Independent Mortgage Bankers

2020 was one of the best loan origination years on record for Independent Mortgage Bankers and bank owned mortgage operations. The MBA Quarterly Mortgage Bankers Performance Report recently released the fourth quarter 2020 origination volume and profit margins. The average funding volume for Q4 was 1.47 billion per company, up from $1.34 billion per company in Q3.  Companies were also able to fund more unit numbers of loans in Q4 with an average mortgage count of 5,049, up from 4,732 in Q3. In addition, the average loan amount came in at an all time high of $287,311 up from $282,659 which is a ten percent increase!

This sounds like a particularly good 2020 to most mortgage observers. Given all the good news,  why are folks in the C suite staying awake at night? The answer is in “The rest of the story”.


The Worst of Times for Independent Mortgage Bankers?

Interest rates are rising quickly. The GSE’s are reporting the highest 30-year interest rates since last August.  The 10-year treasury shot up this week to its highest in more than a year as the economy continues to recover. An improving economy is putting pressure on inflation which will lead to higher rates and lower refi activity. Bond markets are nervous in expectation of fed policy tightening sooner than later.

Gain on sale dropped dramatically in the Q4 from Q3- from $5,535 per loan to $3,738 in Q4.  Will this trend continue? 

Productivity is down.  Traditionally, higher volume levels have meant lower per loan costs that resulted in higher productivity. Not the case this time. Production costs rose for the second straight quarter ending with Q4 at a staggering $7,938 per loan.  Most of this increase was due to hefty personnel costs that were taken on in 2020.

New refi applications have slowed dramatically.  Higher rates obviously mean less refi demand with IMB’s fixed expenses remaining the same.

Purchase money loans are down. Purchases by volume decreased to 43% compared to 46% percent in Q3 driven by lack of housing inventory. In most parts of the country housing inventory levels are at historic lows- less than a 60-day supply. There just are not enough houses under construction or residential lots under development. 


A Tempting Solution to Combat Margin Compression

Strategic Inflection Point.  The mortgage industry is about to enter a loan production crossroad. How to grow your business, maintain loan production, manage fixed expenses, and generate reasonable GOS. Many lenders may look to the Non-QM market for a solution. Non-QM can be originated in retail as well as third party channels and attract purchase as well as refinance loans.  

If this is the path you chose to go down, you must ask yourself these questions:

  • Is this the best solution for you? 
  • What are the risks? 
  • Can the production be scaled to warrant the time and effort? 
  • What is the real liquidity of these loans? 
  • Are these loans subject to repurchase demands? 
  • If you must repurchase a loan where would you resell it? 
  • How deep is the investor base for these loans? 

These are all very real and important questions. Obviously Non QM lending has its risks: Limited liquidity. 


How Independent Mortgage Bankers Can Take Advantage of the Current Market

As an alternative, many lenders are looking to “purchase centric” loan products focused on new construction and renovation lending. While construction loans are not without risk, risk is managed by following proven industry best practices. Construction- to- Perm (CTP) loans are consumer driven loans and often originated in the conforming GSE market as well as the government loan market.  Fannie Mae, Freddie Mac, FHA, VA and USDA all offer consumer Construction-to-Perm loan products.  

These new hybrid construction-to-perm loans are all 30-year mortgages. They are sometimes referred to as “One Time Close” by originators.  Fannie Mae refers to their product as a “Single Close CTP”, Freddie Mac refers to their product as a “Construction Conversion Mortgage”. FHA, VA, and USDA all have similar consumer construction loan programs that have been around for many years. It is notable that USDA offers a “single close” construction-to-perm that is immediately securitizeable into GNMA MBS, even before completion of the house.  This allows the lender to book the “Gain on Sale” before the house has even been built.  This feature is unique to USDA lending. 

Renovation loans are also 30-year mortgages. Renovation loans are like construction-to perm-loans in that the appraised value is based on the AFTER completed value. Fannie Mae and Freddie Mac will buy 30-year renovation loans as soon as they are closed with the lender disbursing the escrowed renovation funds based on progress inspections.  FHA is very well known for its 203K renovation loan, which is also GNMA securitizable as soon as it is closed and prior to renovation completion. 


The GSE’s and government insured loans offer a high degree of proven and known liquidity.  Most IMB’s already sell loans to the GSE’s and/or securitize government insured loans through Ginnie Mae, all known and proven entities.  

So, what is the opportunity here? Pretty simple. There are not enough single-family homes in this country. There is not going to be enough single-family homes in this country. Probably not in your lifetime.  This is a generational problem.  The only event like this was at the end of WW2 when millions of American service people returned to the US mainland for discharge from the military. This caused the household formation numbers to skyrocket that triggered a housing construction boom that lasted well into the late 60’s.  The financial crisis of 2007-2008 left the housing market with excess housing inventory so new construction virtually stopped. Those inventory levels were eventually worked off by 2012-2013 but the new home construction market has struggled to catch up. This is why new home construction is at an all time high but the runway is long and vast. 


To survive margin compression, you must expand your loan offerings with construction and renovation lending. To learn more about the best practices of CTP and renovation lending, contact Land Gorilla today

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