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Mortgage Hedging: Part I

Posted by Don Kracl on May 19, 2011 10:20:00 AM

For information on Mortgage Hedging and Secondary Marketing solutions, look here.

 

[hedge] A securities transaction that reduces the risk on an existing investment position.

 

An issue circling the mortgage industry for years now is the idea of managing risk or hedging your pipeline. It seems there are a number of interpretations as to what this is and should mean to your pipeline. One idea is to absolutely minimize your risk. Perhaps the easiest way to accomplish this in the mortgage business is to give your potential borrower the option to lock or float at their option. This assumes a couple of things:

 

Mortgage Hedging1) Your consumer is armed with sufficient information to make an informed decisions about their mortgage

 
2) You don’t get caught in a rate “squeeze” or the situation where they decide to lock as the market is moving either by design (unlikely) or dumb luck.

What if you could lock in the loan for the amount of profit you desire?  An ideal situation, right? Something akin to a farmer planting their corn in spring, knowing exactly what their yield will be, their fuel, fertilizer and labor costs, etc. Then selling exactly what they want for profit. Any farmer will tell you it’s a fairy tale, but it would be a pretty sweet deal.

 

So let’s see what we have in the mortgage hedging business. Let’s say you’re busily taking applications and allowing the consumers to lock their rates in whenever they feel comfortable doing so. As a company, we’ll just wait until the loan closes and then decide what it is we’re going to do. If the market improves, we win. If the market worsens, we lose. One problem with this situation is that if the market improves, the likelihood that a consumer is going to stay with you at their previously locked in (worse) rate is lower than if the opposite happens. So your exposure to negative risk is greater if the market worsens (you lose more money) than if the market improves (you make more money)! Not really a fair trade.

 

So everyone really wants to know what they’re going to get...sort of. The consumer usually wants a one way street, right? That is, if the market improves they want that, if the market worsens, they want a bargain. Hardly fair, but it’s the reality.

So how do we manage our risk? One simple way is to do whatever the consumer does. That is, if the consumer locks, we lock; if the consumer floats, we float. Not very complicated, pretty safe and as long as we don’t get caught in “the squeeze” it could work. It’s easy to understand and implement but also not very sophisticated. 

 

See how Mortech's partnerships with mortgage hedging companies provide a robust secondary marketing solution with our mortgage pricing engine.

 

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Topics: mortgage hedging

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