What it means
A mortgage originator, such as a non-bank lender, makes a loan to a home buyer but usually does not want to keep it. Instead it plans to sell the loan, often to an investor or a government-backed agency, within a few weeks.
In the meantime it needs money to fund the next loan. A bank provides a revolving credit line, called a warehouse line, that advances most of each loan's value.
The originator contributes the rest from its own funds. The loan sits in the warehouse, which means it is pledged as collateral, until the sale proceeds repay the advance.
The advance rate, the share of the loan the bank will fund, is usually a little below the full amount, and the gap is called the haircut. The originator also pays interest on the advance and fees for the line, and the lender typically has limits on how long a loan can stay before it must be sold.
Warehouse lending lets originators grow without large amounts of their own capital, but it adds risk. If the sale is delayed, if interest rates move against the originator, or if the loan has a defect that makes it unsaleable, the originator may have to repurchase the loan or meet extra margin calls.
For finance teams, the main measures are the cost of funds, the time loans spend on the line, and the headroom left on the facility. Lenders watch these closely because a squeeze on the line can stop an originator from making new loans.
In practice
Real-world examples.
Example
A regional mortgage company closes 300 loans in a month with a total value of $90,000,000. It uses a warehouse line to fund the loans and repays the line as each batch is sold. Without the line it would have to hold the full amount in cash.
Example
A start-up lender with limited capital is approved for a $25,000,000 line. It originates loans up to that limit and must sell them within 30 days. A delay in the investor's purchase leaves it close to the limit and unable to fund new loans.
Example
A lender discovers that a loan on its warehouse line has a missing document, so the investor refuses to buy it. The bank requires the lender to buy the loan out of the line or move it to a lower-rated section. The lender absorbs the cost of the delay.
Formula
Calculation
Warehouse advance = Loan amount x Advance rate
Interest cost = Advance x Annual rate x (Days on the line / 360)
Net gain on sale = Sale proceeds - Loan amount - Interest cost
A lender funds a $400,000 mortgage using a warehouse line with a 98% advance rate. Advance = 400,000 x 98% = $392,000, so the lender supplies 400,000 - 392,000 = $8,000 of its own cash. The loan is on the line for 20 days at an annual rate of 7%. Annual interest on the advance = 392,000 x 7% = $27,440, so interest cost for 20 days = 27,440 x 20 / 360 = $1,524.44. The loan is sold at 101% of its balance, so the sale proceeds = 400,000 x 101% = $404,000. Net gain = 404,000 - 400,000 - 1,524.44 = $2,475.56, before other fees and staff costs.Case study
Seen in the real world.
Pinecrest Home Loans is an illustrative, fictional non-bank mortgage lender with $6,000,000 of its own capital. It arranged a $60,000,000 warehouse line with a 97% advance rate, so the lender had to supply 3% of each loan.
The company funded loans of $300,000 each, so it supplied 300,000 x 3% = $9,000 per loan. With $6,000,000 of its own cash, it could cover that 3% share on about 6,000,000 / 9,000 = 666 loans, so the $60,000,000 limit on the line was the tighter constraint.
In the illustrative result, the line allowed the firm to originate ten times its own capital in loans. However, when investor purchases slowed for a month, loans stayed on the line longer, interest costs rose and the firm had to cut back its lending until the line cleared.
Watch out
Common mistakes.
- Assuming a warehouse line funds the whole loan, when the originator normally supplies a share from its own cash.
- Ignoring the time loans sit on the line, which drives up interest cost and can breach the line's age limits.
- Failing to keep documents complete, because a loan with defects may not be bought and can force the lender to repurchase it.
Questions
People also ask.
Why is it called a warehouse line?
Because the loans are held as collateral, or stored, for a short time while they await sale, much like goods in a warehouse.
Who provides warehouse lines?
Banks and specialist finance companies, which lend against the mortgages and monitor them closely.
What risks does the lender face?
Delays in selling, interest rate moves, loan defects and limits on the line, any of which can raise costs or restrict new lending.
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