Your lender agrees to supply the cash for you to buy your home. As part of the lending contract, you, as the borrower, agree to pay interest based on the number of years it takes to repay your loan. You view your mortgage as a way to pay for your home, but investors view your mortgage as a way to earn income from servicing your loan and packaging your loan with other mortgages or other investments as a product to buy, sell and trade to other investors.
Secondary Mortgage Market
Mortgage brokers fund loans and then resell the mortgages to large lenders. This resale allows the brokers to make a profit from the sale of the loan and sometimes from the service fee incorporated into the loan payments. Borrowers paying 6 percent interest under this arrangement, for example, remit the full payment each month. The mortgage company keeps a small servicing fee and transfers the remaining payment to the new lender. Investors interested in this arrangement look for highly qualified borrowers with a long history of meeting loan payments and a clear credit report. Brokers typically sell these mortgages during the first few months after closing escrow.
Some credit unions, savings and loans and lending banks sell their fixed-rate mortgages with low-interest rates to other investors. The banking institutions must balance loans with interest paid on current and future deposits, and selling low-interest mortgages to investors is one way to raise capital. This new capital allows the institution to make new loans at higher loan rates and also pay higher interest rates to depositors. Money used to fund low-interest rate mortgages fails to supply the cash to pay higher interest rates to compete with other savings institutions for depositors.
Collateralized debt obligations (CDOs) allow investors to buy securities backed by products with cash value. Lenders bundle asset-backed securities, home mortgages in this case packaged as mortgage-backed securities (MBS), into pools along with other assets and market these to investors. Investors find some mortgages made to high-risk borrowers less attractive compared with other mortgages made to more-qualified buyers. Lenders mix borrower types and also mix the mortgages with other securities maturing over a range of years in the CDOs products. This type of mortgage resale allows investors to regulate the cash flowing into portfolios. Investors also buy CDOs believing the return exceeds other types of investments, such as federal Treasury bills.
Banking institutions with a large percentage of investments in delinquent mortgages or loans made to high-risk mortgagees frequently sell these loans to investment companies to remove the risk or the bad debt from the institution's financial books. Banks selling these notes must report the level of risk of the mortgages to the new investors or risk federal fines.