When you take a loan, the bank can “sell” your loan to an investor. What does that process look like, and why would an investor want to buy loans?
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Most comments talk about why but not how.
The actual process usually goes like this.
When you open a savings account at a local bank, they loan that money out to someone else and collect interest on it. The local bank is only allowed to use a certain percentage of their savings deposits for loans.
In order to create more loans, and generate more fees they sell their existing loans to a institutional bank (IB) like Chase with the agreement they will still do all the customer service for a small fee but IB collects the vast majority of the interest and now owns all the risk associated with that loan. The local bank then uses the proceeds from the sale to generate more loans.
IB doesn’t want to lock up all their money in loans either, so they collect all the loans from all over the country and create a single security (think one loan made up of all the other loans) with a very specific risk metric based on loan types house types and credit worthiness of the recipients. They are able to sell shares of this security to the broader financial market and free up their money.
The investors who bought the security hold it to collect the stable interest rate. These are often insurance companies, private wealth funds, and pension funds.
So your loan now has three institutions benefiting
Local bank: percentage fee for creating and servicing the loan.
Institutional bank: percentage fee for packaging and servicing the security.
Investors: the majority of the interest.
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