22.03.2023 - 22:30

When mortgage originators sell mortgages to Fannie Mae, Freddie Mac, and investment banks, the originators have no additional liability for possible default by the borrower. How will this arrangement influence the incentive of the originators to scrutiniz

Question:

When mortgage originators sell mortgages to Fannie Mae, Freddie Mac, and investment banks, the originators have no additional liability for possible default by the borrower. How will this arrangement influence the incentive of the originators to scrutinize the creditworthiness of the borrower? Would the incentive structure be different if the originator planned to hold the mortgage until it was paid off? Why or why not?

Answers (1)
  • Irishka-IriS
    April 6, 2023 в 21:38

    When mortgage originators sell mortgages to entities like Fannie Mae, Freddie Mac, and investment banks, they transfer the risk of default to those entities. As a result, the originators have no additional liability for any possible default by the borrower.

    This arrangement can influence the incentive of the originators to scrutinize the creditworthiness of the borrower. Since they are no longer bearing the risk of default, they may not be as careful in evaluating the creditworthiness of the borrower as they would if they planned to hold the mortgage until it was paid off. This could result in them originating riskier mortgages that may have a higher likelihood of default.

    In contrast, if the originator planned to hold the mortgage until it was paid off, they would have a greater incentive to scrutinize the creditworthiness of the borrower. This is because they would bear the risk of default, and a default could result in a loss for the originator. Therefore, they would be more cautious in evaluating the creditworthiness of the borrower and would be more likely to originate less risky mortgages.

    In summary, the incentive structure for mortgage originators would be different depending on whether they plan to hold the mortgage until it is paid off or sell it to another entity. If they plan to hold the mortgage, they have a greater incentive to scrutinize the creditworthiness of the borrower, whereas if they sell it, they may be less careful in evaluating the creditworthiness of the borrower.

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