There are several aspects of 'selling a mortgage'. It's a question that cannot sufficiently be answered in full in one article, but I'll do my best to explain.
When a lender originates a loan they have 3 options:
Retain the loan on their portfolio, and receive monthly payments of principal and interest to pay back the loan. In this case they are fully exposed should the borrower stop paying.
The second option is to sell the loan "service retained". In this case, the bank will sell the "asset" that is the mortgage loan, but will retain servicing of the loan. This means that you will still make the payment to that bank, however that loan is no longer on the books of that bank. Should the borrower default, the bank is only partially responsible for the loan. This form of 'selling' is typically done to GSE's (Fannie Mae and Freddie Mac). Most all conforming loans are sold service retained. We'll come back to why, and how this helps the economy later.
Service releasedis the third option. In this case, the lender sells the asset, and the servicing of the loan to another lender. The originating bank is no longer affiliated with the loan at all, as the payments are now made to the lender who purchased the loan. This was more prevalent in subprime lending than in conventional or conforming loans, because, as a whole Fannie Mae and Freddie Mac didn't not purchase subprime loans.
As to how this helps
keep rates low, you have to understand the rest of the sales process. We'll focus on conforming loans here for the sake of simplicity. Once the bank sells the loan to Fannie or Freddie, they package that loan along with many other similar loans into a financial instrument known as a mortgage backed security. Bond investors, pension funds, foreign governments, or even individuals can then invest in that security just as they would any other. When a borrower makes their payment, funds are accepted by the servicing bank, who takes a small piece (typically 1/8th of 1 percent) for servicing the loan, and passes the remainder to Fannie Mae. Fannie then takes a piece for their involvement, and disburses the rest of the payments to the investors in the mortgage backed security.
This keeps rates low, and helps the economy keep moving because this process (know as securitization), allows a bank to move the money off their balance sheet, and lend to someone else. If this process did not exist, a bank would have to keep every loan they wrote on their books. If a bank had, for example, $500 million in deposits, they would never be able to lend above that amount, as they would be lending out the funds of their depositors and once the funds ran dry, no more loans. Think of the scene from It's a Wonder Life. What if you wanted to go to the bank and close your account and they told you they didn't have the money because it was lent out on a mortgage? This type of activity fueled the bank runs of the Great Depression.
By a bank being able to write a loan, and sell that loan, they are able to get their money back to lend again. This insures that someone who is qualified is able to obtain financing regularly. Additionally, rates are able to stay low because that bank hasn't lent the money for 30 years, which would require more risk, and therefore a higher return. Buyers and sellers of mortgage backed securities can move in and out of the investment as their situation permits, retaining liquidity in the entire market.
Without securitization, and end money coming from investors, pension funds, sovereign entities, etc the pool of available lending funds would be limited to the amount of deposits at a given bank. Hopefully this gives you some insight as to why selling a mortgage is a necessary part of our economy.
Answer Submitted on Fri, Nov 7 2008
Rate this Answer: