Written by Nema Daghbandan Esq. CEO of Lightning Docs, and Melissa Martorella, Esq. Partner of Geraci LLP
If you are a private lender, you have probably heard a combination of these words thrown out. Worse, you have probably heard the same term described in different ways. So, what exactly do these terms mean for private lenders and how should you properly document these loans?
Direct Lending / Balance Sheet Lending / Retail Lending
First, all the terms identified above describe something other than direct retail lending. A direct lender, balance sheet lender, or retail lender is someone who uses their own loan funds (often through a mortgage fund) to fund a business purpose loan transaction. When a loan originator relies on third-party capital the remainder of these terms come into play.
Wholesale Lending
Wholesale lending in this context is used when a loan originator, typically a mortgage broker, receives a loan request that they do not intend to fund directly and brokers the transaction to a wholesale mortgage lender. For example, if a lender typically makes fix and flip loans and receives a request for a 30-year term Debt Service Coverage Ratio (DSCR) loan they can work with a wholesale lender to try to fund the loan. In this arrangement, the loan originator will often receive and process the loan application provided by the wholesale lender and work directly with the wholesale lender to qualify the loan borrower. The loan funds in the name of the wholesale lender and the loan originator typically receives a loan fee (points) for helping arrange the loan to the wholesale lender. Sometimes the wholesale lender will also offer additional compensation to the loan originator if they can obtain favorable deal terms with the borrower such as negotiating a higher interest rate and/or provide an exceptionally qualified borrower with high FICO scores and low loan to value ratios for example.
           Documentation
From a loan documentation perspective, the wholesale lender will choose the form of mortgage loan documentation. The wholesale lender is the named lender in the loan documents. Typically, the mortgage broker receives a broker fee on the settlement statement.
           Licensing & Other Practical Considerations
Wholesale lending is not a new concept. Wholesale lending is simply a synonym for loan brokering that is made to sound fancier. From a mortgage licensing perspective, the loan originator may be required to have a mortgage broker or similar license to broker the loan to a wholesale mortgage lender.
White Label
The terminology white label or white labeling is a fairly new terminology to the private lending space which was pioneered by some of the largest national private lenders.
In reality, white labeling is almost identical to wholesale lending, meaning that the loan originator chooses not to fund the loan with its own funds, and instead chooses to broker the loan to a funding party.
What’s different here is that in the wholesale lending situation, all parties know that the loan originator is NOT the funding source. The loan borrower is fully aware that the wholesale lender is the funding source and not the loan originator.
However, in a white label situation, the funding source creates a generic named mortgage lender (for example “Funding Lender LLC”) intentionally so that the loan borrower believes there is an affiliation with the funding source and the loan originator even though the parties have no relationship. Here, the loan originator typically makes assertions to its borrowers that they are a direct lender and a capital provider even though the source of the loan funds will be coming from a third party.
           Documentation
Like wholesale lending the funding source will choose the form of mortgage loan documentation. The funding source is the named lender in the loan documents, however, here the funding source typically creates a generically named entity as the funding source that is often different than the trade name provided to the public at large so that the loan borrower believes the loan originator is being named in the loan documents and not a 3rd party funding source. Depending on the arrangement the loan originator may or may not earn fees directly through the settlement statement, often the loan originator is paid after loan closing so that the borrower is unaware of the fact that the loan originator did not directly fund the mortgage loan.
           Licensing & Practical Considerations
Unlike wholesale lending, the borrower is led to believe that the loan originator is the funding source. If done poorly the loan originator and/or the funding source could be alleged to have made misrepresentations to the borrower. To counter this, funding sources typically require an agreement with the loan originator where the loan originator provides representations and warranties to the funding source confirming they are properly licensed, will not make any misrepresentations to the borrowers, etc. Identically to the wholesale lending scenario, the loan originator may be required to have a mortgage broker or similar license to broker the loan to the white label funding source. The white label funding source may be required to have a mortgage lender license depending on the jurisdiction of the loan.
Finally, as a practical note, typically law firms or other trusted third-party intermediaries are brought in for the loan closing so that the funding source can have visibility of what is happening in the loan closing without directing the activities at loan closing accidentally revealing to the loan borrower the true identity of the loan funding source. The law firm typically acts as the “voice” of the loan funding source at loan closing, with the borrower not aware of the fact that the law firm is acting for the benefit of the loan funding source and not the loan originator.
Table Funding
Table Funding is like white labeling in which the loan originator would like the borrower to believe it is the funding source for the loan but instead, the loan will be funded by a 3rd party funding source. However, unlike white labeling, the loan originator is the named lender in the loan documents. The funding party funds the loan at the closing table (hence the term table funding) and an assignment of the loan is recorded along with the original mortgage assigning the loan from the loan originator to the loan funding party.
Table funding provides the same benefits to the loan originator as white labeling, allowing them to market to the borrower that they are the funding source and a direct lender. Additionally, it offers the added advantage of being named as the lender in the loan documents, eliminating the need for any misrepresentation to the borrower.
           Documentation
The loan funder will control the form of loan documentation. However, the loan originator will be named as the lender in the loan documents. The loan originator executes an original Assignment of Mortgage and provides it to the Closing Agent. The Closing Agent records the original mortgage and the original Assignment of the loan legally transferring ownership of the loan at the same time as the mortgage is recorded.
            Licensing and Practical Considerations
Even though the loan originator is not the funding source here, they are effectively as close to a direct lender without actually funding the loan. However, unlike the white label where the ultimate funding source is the named lender, the parties must make sure that the loan was transferred to the funding source. Similarly, unlike a white label loan where the property insurance and the title insurance are always in the name of the funding source, the parties must pay special attention to make sure that the funding source is either the additional insured or the original insured.
From a licensing perspective, the loan originator may be required to be a licensed mortgage lender. In rare instances, the funding source may also be required to be licensed as a mortgage lender. However, it is important to note that California does not permit table funding as the state requires the funding source to be the named lender in the loan documents.
Correspondent Lending
Correspondent lending typically occurs when a loan originator works directly with the borrower and funds the loan with their own capital but intends to immediately sell the loan to a loan buyer. Rather than rely on the originator’s typical underwriting and loan requirements, the loan originator looks to the loan purchaser’s requirements. Correspondent lending typically takes one of two forms:
           Non-Delegated Underwriting
Non-delegated underwriting means the loan purchaser directs all underwriting decisions. The loan originator effectively acts as a loan processor on behalf of the loan purchaser. The loan purchaser requests whatever documentation it needs to qualify for the loan and makes the ultimate decision about whether the loan should be made. The loan purchaser in this context effectively guarantees the purchase of the loan after the loan closing. The loan originator receives certainty, however, because this approach takes up the resources of the loan purchaser, the loan originator tends to receive less compensation from the loan purchaser when the loan is sold to the loan purchaser.
Delegated Underwriting
In a delegated underwriting approach, the loan purchaser allows the loan originator to work with and underwrite the loan borrower directly. The loan purchaser may commit to purchasing the loan but does not necessarily have to, leaving potential risk to the loan originator in which the loan originator makes the loan, but the loan purchaser does not actually buy the loan post loan closing. Because the loan purchaser does not have to use its own underwriting resources during loan origination, they tend to pay greater premiums when they purchase the loan from the loan originator.
Documentation
From a loan documentation perspective, the loan originator is named as the original lender. They then enter an Assignment of the loan to sell the loan to the loan purchaser. Correspondent lenders will typically provide or mandate the form of loan documentation.
Licensing and Practical Considerations
Correspondent lending is an old concept and is most commonly found in the conventional mortgage banking world. In the conventional mortgage banking context, non-bank mortgage loan originators typically fund loans in their own name with funds coming from a warehouse line of credit, and the loans are then sold to the funding source, a Bank and/or the federal agencies Fannie Mae or Freddie Mac. The loan originator is compensated through a “gain on sale” in which they are paid a premium over the value of the loan when the loan is sold.
The private lending world operates very similarly, however, there are no federal agencies and banks to sell the loans to so instead, the loans are sold to private loan purchasers. Therefore, the loan originators must be very careful to adhere to the standards of the loan purchaser and understand their guidelines. Similarly, issues can arise if the loan originator makes mistakes in the loan documentation such as not identifying the correct signing parties or other errors which would normally be cleared through underwriting.
From a mortgage licensing perspective, licensing requirements are identical to that of table funding in which the loan originator will be required to be licensed as a mortgage lender, and in rare instances, the loan purchase may also be required to be licensed as a mortgage lender.
What Should You Do Next?
Hopefully, you have found this article informative. This article barely brushes the surface of each topic and private lenders who are interested in learning more will want to consult with counsel to understand the entire legal and practical framework for each approach above. Geraci LLP, as the nation’s largest private lending law firm can provide legal, licensing, and loan closing services providing peace of mind to loan originators and funding sources. Lightning Docs, as the gold standard in business purpose loan documents, provides an off-the-shelf loan document solution allowing private lenders to make these loans with appropriate documentation anywhere in the country.
