What is 'Mortgage Fallout'
Mortgage fallout refers to the percentage of loans in a mortgage originator’s pipeline that fail to close. This number is considered a significant indicator of the originator’s efficiency. Mortgage originators base their hedge ratios on their fallout assumptions. Fallout assumptions change as interest rates change, since interest rates will generally affect the amount of borrowers seeking and being approved for loans.
Mortgage originators may be individual mortgage brokers, mortgage companies or mortgage bankers. They assist the prospective borrower in finding and attaining a mortgage. They themselves may not be lenders, but part of their role is to bring the prospective borrower and the potential lender together.
BREAKING DOWN 'Mortgage Fallout'
Mortgage fallout is calculated based on the number of loans for which a lender locks in an interest rate for the borrower. Once locked in, that borrower is in the lender’s pipeline. Of course, interest rates may still change before the loan closes. Thus, the lender will hedge against this to protect themselves. The hedge lasts until the mortgage closes. Once the mortgage closes, it can be sold into the secondary mortgage market.
However, many loans locked in by borrowers do not end up closing. Lenders can study historical data on mortgage fallout percentages within various market conditions in order to more accurately predict what their mortgage fallout may be. Adjusting their hedging strategy around calculated fallout risk can significantly increase a lender’s profit.
Why mortgage fallout occurs
Mortgage fallout may occur for a number of reasons. For example, a borrower may seek a mortgage to buy a condo, believing that they’ll soon sell a house that they already own. The sale of that house will allow them to qualify for the loan. However, if the house does not sell within a certain amount of time, they may not be able to attain the mortgage, because their income and assets would not be sufficient to cover the monthly payments. This scenario became quite common in the wake of the financial crisis of 2008.
A loan’s terms may also specify that once the lender locks in an interest rate, the borrower still has the ability to back out of the loan. Thus, if interest rates decrease before the loan closes, the borrower may choose to back out of the loan in favor of seeking out a loan with a lower interest rate. However, if interest rates rise before the loan closes, the borrower will likely stick with the lender, as long as they are approved.