Define: Loan Origination

Loan Origination

Quick Summary of Loan Origination

Loan origination refers to the process by which a lender evaluates, approves, and establishes a new loan for a borrower. It involves several steps, including the initial application, verification of the borrower’s creditworthiness, assessment of the proposed loan’s terms and conditions, and eventual funding of the loan. During loan origination, lenders typically gather information about the borrower’s financial history, income, assets, and liabilities to assess their ability to repay the loan. This process may also involve determining the appropriate interest rate, loan amount, and repayment schedule based on the borrower’s financial profile and the lender’s lending criteria. Once the loan is approved and finalised, the borrower and lender enter into a formal agreement outlining the terms and conditions of the loan, including repayment obligations, interest rates, and any applicable fees or charges.

Full Definition Of Loan Origination

Loan origination is the process by which a borrower applies for a new loan, and a lender processes that application. Origination generally includes all the steps from taking a loan application through disbursal of funds (or declining the application). Loan servicing generally covers everything after disbursing the funds until the loan is fully paid off. Loan origination is a specialised version of new account opening for financial services organisations.

There are many different types of loans. steps involved in originating a loan vary by loan type, various kinds of loan risk, regulator, lender policy, and other factors.

Application Process

Applications for loans may be made through several different channels and the length of the application process, from initial application to funding, means that different organisations may use various channels for customer interactions over time. In general, loan applications may be split into three distinct types:

Agent-assisted (branch-based)
Agent-assisted (telephone-based)
Broker sale (third-party sales agent)
Self-service

Retail loans and mortgages are typically highly competitive products that may not offer a large margin to their providers, but through high volume, sales can be highly profitable. The business model of the individual financial institution and the products they offer therefore affect which application model they will offer

Agent-Assisted (Branch-Based) Loan Application

The typical types of financial services organisations offering loans through the face-to-face channel have a long-term investment in ‘brick and mortar’ branches. Typically, these are:

Banks
Credit Unions
Building Societies

The appeal to customers of the loans offered directly in branches is the often long-standing relationship that a customer may have with the institution, the appearance of trustworthiness this type of institution has, and the perception that holding a larger portfolio of products with a single organisation may lead to better terms. From a bank’s standpoint, cross-selling products to current customers offers an effective marketing opportunity, and agents in branches may be trained to handle the sale of many different types of financial products.

In a branch, customers typically sit with a sales agent who will assist the customer in completing the application form, selecting appropriate product options (such as payment terms and rates), collecting required documentation (new account opening compliance requirements must be met at this stage), selecting add-on products (such as payment protection insurance), and eventually signing a completed application.

Depending on the institution and product being offered, the application may be completed on a paper application form or directly into an online application through the agent’s desktop system. In either case, this phase of the application is mostly concerned with the accurate capture of customer’s details and does not incorporate any of the background decision-making work required to assess the suitability of the customer and the risk of default, or the due diligence that must be performed to mitigate the risk of fraud and money laundering activities.

A major complexity for the branch origination channel is making the process simple enough that sales agents can be easily trained to handle many different products while ensuring that the many due diligence and disclosure requirements of the financial and banking regulators regionally are met.

Many back-office functions of loan origination continue from this point and are described in the Processing section below.

Agent-Assisted (Telephone-Based) Loan Application

Broker-Sourced (Third Party Sales Agent) Loan Application

Self-service Loan Application

Self-service web applications are taken in a variety of ways, and the state of this business has evolved over time
Print and fax applications or pre-qualification forms. Some financial institutions still use them.
- Print, write or type data into the form and send it to the financial institution
- Fill out the form on the web, print, and send to the financial institution (not much better)
Web forms filled out and saved by the applicant on the web site are then sent to or retrieved by (ostensibly securely) the financial institution
True web applications with interfaces to a loan origination system on the back end
- Many of the early solutions had a lot of the same problems as general forms (bad workflows, trying to handle all manner of loan types in one form)
Wizard-style applications that are very intuitive and don’t ask superfluous questions

Jobs the online application should perform:

Present required disclosures and comply with various lending regulations.
Be compliant with security requirements (such as Multi-Factor Authentication) where applicable.
Collect the necessary applicant data
1. Exactly what is needed varies by loan type. The application should not ask for data the applicant doesn’t absolutely have to provide to get to a prequalification decision for the loan type(s) they seek.
2. The application should pre-fill demographic data if the applicant is an existing client and has logged in.
Make it easy, quick, and friendly for the applicant (so they actually complete the application and don’t abandon)
Get a current credit report
Prequalify (auto-decision) the application and return a real-time response to the applicant. Typically, this would be approved subject to stipulations, referred to the financial institution, declined (many FIs shy away from this, preferring to refer any application that can’t be automatically pre-approved.)

Processing

Decisioning & credit risk

The mortgage business consists of a few people: the borrower, the lender, and sometimes the mortgage broker. The people who originate the loans are usually the mortgage broker or the lender. Depending on whether the borrower has creditworthiness, he or she can be qualified for a loan. The norm qualifying FICO score is 620 for SISA/SIVA loans and 600 for Full Documentation Loan loans. Depending on what the borrower’s credit scores are, the lender can assess the risk they may take.

Not only does one’s credit score affect their qualification, but the fact of the matter also lies in the question, “Can I (the borrower) afford this mortgage?” In most cases, the borrower can afford their mortgage. However, some borrowers seek to incorporate their unsecured debt into their mortgage (secured debt.) They seek to pay off the debt that is outstanding. These debts are called “liabilities.” These liabilities are calculated into a ratio that lenders use to calculate risk. This ratio is called the “Debt-to-income ratio” (DTI). If the borrower has excessive debt that he/she wishes to pay off, and that ratio from those debts exceeds a limit of DTI, then the borrower has to either pay off a few debts in a later time or pay off just the outstanding debt. When the borrower refinances his/her loan, they can pay off the remainder of the debt.

Example: if the borrower owes $1,500 in credit cards and makes $3,000 in a month: his DTI ratio would be 50%. But if the borrower owes $1,500 and makes $2,000 in a month, his DTI ratio would be 75%. This ratio is seen by many lenders as high and too risky a person to lend to and may or may not be able to afford the mortgage. So that covers qualification; now on to appraising collateral.

Pricing, including Risk-based pricing & Relationship-based pricing

Pricing policy varies a great deal. While you probably can’t influence the pricing policy of a given financial institution, you can:

Shop around
Ask for a better rate; some financial institutions will respond to this, some won’t
Price match: many financial institutions will match a rate for a current customer

Pricing is often done in one of these ways. Follow the internal links for more details:

Everyone pays the same rate. This is an older approach, and most financial institutions no longer use this approach because it causes low-risk customers to pay a higher rate than the market rate, while high-risk customers get a better rate than they might otherwise get, causing the financial institution to get a lower rate of return on the loan than the risk might imply.
Risk-based pricing. With this approach, pricing is based on various risk factors, including loan to value, credit score, and loan term (expected length, usually in months).
Relationship-based pricing is often used to offer a slightly better rate to customers who have a substantial business relationship with the financial institution. This is often a price improvement offered on top of the otherwise computed rate.

Loan-Specific Compliance Requirements

Many of the customer identification and due diligence requirements of loan origination are common to the opening of new accounts for other financial products.

The following sections describe the specific requirements of loans and mortgages.

Loan Amortisation

Fees and ‘Points’

Fees, including loan origination fee

Truth in Lending

Disclosures

Cross-selling, Add-on Selling

Add-on Credit Insurance & Debt Cancellation
Credit cross-selling
Up-selling
Down-selling
Refinancing
Loan Recapture

Appraising Collateral

The next step is to have a Real Estate appraiser appraise the borrower’s property that he wishes to have the loan against. This is done to prevent fraud of any kind by either the borrower or the mortgage broker. This prevents frauds like “equity stripping” and money embezzlement. The amount that the appraiser can borrow from either the borrower’s side or the lender’s side is the amount that the borrower can loan up to. This amount is divided by the debt that the borrower wants to pay off plus other disbursements (i.e., cash-out, 1st mortgage, 2nd mortgage, etc.) and the appraised value (if a refinance) or purchase price (if a purchase) {whichever amount is lower} and converted into yet another ratio called the loan-to-value (LTV) ratio. This ratio determines the type of loan and risks the lender is put up against. For example, if the borrower’s house appraises for $415,000 and they wish to refinance for the amount of $373,500, the LTV ratio would be 90%. The lender may also put a limit on how much the LTV can be; for example, if the borrower’s credit is bad, the lender may limit the LTV that the borrower can borrow. However, if the borrower’s credit is in good condition, then the lender most likely will not put a restriction on the borrower’s LTV. LTV for loans may or may not exceed 100%, depending on many factors.

The appraisal would take place on the location of the borrower’s property. The appraiser may take pictures of the house from many angles and will take notes on how the property looks. He/she will type up an appraisal and submit it to the lender or broker (depending on who ordered the appraisal.) The appraisal is written in a format compliant with FNMA Form 1004. 1004 is the standard appraisal form used by appraisers nationwide.

Processing Documents/Loan Underwriting

Document Preparation

Electronic Signature

Digital Signature

Mortgage Underwriting

An underwriter is a person who evaluates the loan documentation and determines whether or not the loan complies with the guidelines of the particular mortgage programme. It is the underwriter’s responsibility to assess the risk of the loan and decide to approve or decline it. A processor is the one who gathers and submits the loan documents to the underwriter. Underwriters take at least 48 hours to underwrite the loan, and after the borrower signs the package, it takes 24 hours for a processor to process the documents.

Funding of Loan

Booking
Disbursal of funds

Collateralization & Recording lien

Recording the debt onto the property’s title

Regulation

Lending is a highly regulated business at both the federal and state levels. Some of the main regulations that apply to lending are listed here. For more details, see Bank regulation.

Truth in lending act (aka Regulation Z)
Equal Credit Opportunity Act (aka Regulation B)
Home Mortgage Disclosure Act (HMDA)