Mortgage professionals are not professional stylists, but this doesn’t mean they don’t do haircuts. In the mortgage loan business, a haircut is a reduction applied to the stated or market value of an asset when determining how much credit, financing, or collateral value a lender is willing to recognize. Rather than giving an asset credit for 100% of its value, the lender discounts that value to account for the possibility that the asset could decline in price or be difficult to sell. For example, if mortgage-backed securities have a market value of $1 million and a lender applies a 10% haircut, the lender would recognize only $900,000 of those securities for lending or collateral purposes.
Haircuts are commonly used in mortgage warehouse lending, repurchase agreements, and other transactions in which mortgage loans or mortgage-related securities serve as collateral. The size of the haircut generally reflects factors such as the perceived risk of the asset, its price volatility, liquidity, credit quality, and the time that might be required to sell it. A larger haircut means the lender assigns less collateral value to the asset and provides greater protection against potential losses. In this way, a haircut functions as a risk-management cushion for the party providing the financing.
