What Is Fallout Risk?

Fallout risk is the risk to a mortgage lender that an individual borrower backs out of a loan during the period between the formal offer of a loan and the closing of that loan. A mortgage is a loan that a lender or bank extends to a borrower for the purchase of a home. When a borrower backs out of the loan before signing the documents, called the close, it’s referred to as mortgage fallout.

How Does Fallout Risk Work?

澳洲幸运5官方开奖结果体彩网:Mortgage fallout is a metric that mortgage lenders use, which shows the percentage of loans in their pipeline that haven't closed. Banks and 澳洲幸运5官方开奖结果体彩网:mortgage brokers, which help originate the loans, attempt to forecast the potential mortgage fallout in their loan pipeline. A mortgage pipeline represents all of the mortgage applications that have yet to be approved by a lender but may have had an interest rate lock put in place between the loan ♈applicant and the bank.

Fallout Risk

Typically, 澳洲幸运5官方开奖结果体彩网:mortgage lenders require borrowers to lock in a rate no later than 10 days before꧙ the closing date, but lenders♐ can vary somewhat. The risk that a borrower could back out before the closing date of the mortgage is called fallout risk.

Typically, lenders might extend a loan offer that's good for up to 60 days until the loan closing. In doing so, the bank is at risk that the borrower withdraws from the mortgage agreement during✤ the period prior🍸 to completing the loan transaction.

Secondary Market

If a 澳洲幸运5官方开奖结果体彩网:mortgage originator—who helps to facilitate the loan process—is involved, they'll hold the loan in their pipeline until the loan closes. After which the loan would either go to the bank's loan portfolio or, more likely, be sold in the 澳洲幸运5官方开奖结果体彩网:secondary market.

Oftentimes, a mortgage loan is bundled with other loans to create a 澳洲幸运5官方开奖结果体彩网:mortgage-backed security (MBS). Individuals can invest in an MBS and get paid interest, which is in part based on the interest rates for the loans that make up the MBS. If a borrower backs out of the l⭕oan, the lender loses out on the opportunity to profit from the loan's interest rate and any loan fees. The mortgage originator and the lender can also lose out on the fees that would have been earned had they sold the mortgage loan in the secondary market.

Price Risk

Another component of pipeline risk is known as price risk. This is posed by the probability that prevailing interest rates fall during the period before closing, and the borrower can receive an alternative loan with a more favorable interest rate. S🅠uch a change can threaten the price that the mortgage originator can get for the loan on the secondary market.

How Is Fallout Risk Used?

Common strategies for managing pipeline market risk include using forward sale commitments—direct commitments to sell to the investor at some point in the future—and hedging using capital market instruments.

Hedging Fallout Risk

Fallout risk is an unavoidable aspect of the lending process due to the time it takes to underwrite or process the loan application, financial documents, and all of the legal paperwork that needs to be readied for the closing. During this process, there's a possibility that the borrower withdraws from the mortgage loan. As a result, lenders have a few options available to them that can help to hedge against mortgage fallout and protect themselves from losses.

Government-sponsored Enterprises (GSEs)

One way to do so is to structure the sale of a completed loan on the secondary market on a 澳洲幸运5官方开奖结果体彩网:best efforts basis. An agreement might be made with a secondary loan purchaser, such as 澳洲幸运5官方开奖结果体彩网:Fannie Mae or Freddie Mac, which are 澳洲幸运5官💮方开奖结果体彩网:government-sponsored enterp🌜rises (GSEs) that guarantee, buy,✱ and package loans to be sold as investments.

Under a best-effort basis, the GSE might agree to waive the fee, which would otherwise be charged when the originator cannot deliver a specific mortgage. This can have a downward effect on the price, but this change in price is generally less than the fee.

TBA Market

Another hedge against fallout risk involves the use of the 澳洲幸运5官方开奖结果体彩网:to be announced (TBA) market for mortgage securities. In this market, mortgage lendeꦺrs can sell loans that satisfy certain criteria without identifying the♉ specific loans.

Typically, the securities or loans aren't announced until 48 hours (called the 澳洲幸运5官方开奖结果体彩网:48-hour rule) before the preset settlement date for the transaction in the TBA market. As a result, the lender can replace a loan whose borrower has withdrawn with another completed loan by the settlement date, if necessary.

The Bottom Line

Every lending situation is tenuous until the ink on the contract is dry. For lenders, fallout risk is part of their expected risk calculations, and they do their best to bring borrowers over the finish line. They may also use strategies to lower their risk, like hedging or selling to a GSE on a best effort basis. No matter what, fallout risk remains a constant hurdle in the mortgage market.