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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There’s two ways this can happen.
First, the bank lumps a bunch of loans together and sells a bunch of loans to an investment firm.
Second, is someone fails to pay back their loan, so it’s sold to a collector.
It sounds like you’re asking about the first situation. So here’s what that looks like:
A bank has 200 open loans. They average a value of $10,000,000. And these loans are at 7% APR. This means if the bank wants to just sit on these loans they’ll eventually make back their $10 million plus probably another $5 million in interest. So if the bank *waits* they’ll make $5 million profit. But that will take a number of years. And maybe they want to go make more loans now. So what they’ll do is they’ll sell that debt. They’ll present the finances as I’ve just described them. $10 million loaned out. 7% interest. This stands to return $15 million. We will sell you this $15 million dollar opportunity for $12 million dollars.
So an investor will say “I don’t mind waiting, and I like having steady income.” So an investor will pay the bank $12 million and take ownership of those loans. Now the monthly loan payments go to the new owner of the loans. So they have a steady monthly stream of cash, which will ultimately pay out $3 million more than he paid in.
The bank makes $2 million pretty quickly just by getting people to take loans and then selling those loans. Now they have $12 million worth of loans to offer instead of just $10 million. So they can rinse and repeat but this time with even more money.
This is also basically how refinancing works, except the person paying the loan is more involved. Basically when refinancing you negotiate with a new lender for better terms and they give you the cash to pay off your other loan but now you effectively owe them that loan. Typically you’ll do this when interest rates go down so that you can pay it off faster or pay less each month. Sometimes they’ll reduce the principal for you, if you got kinda screwed the first time around but have otherwise been good. But that’s pretty rare.
So I hope that answers your question.
The other part is collections. If you just stop paying, they’ll sell your debt to a collector. The collector can do more to harass you than the bank can. But obviously they’re working with people that aren’t interested in paying the money back. So a collector will typically pay 1/2 value or somewhere like that to the bank for the full value of the debt. So if you haven’t made payments on a $1 million loan, the collector might pay the bank $500,000 for that debt. And the bank will take it because it’s better than the nothing you’ve paid them. The debt collector can then make your life really shitty until you pay back the money.
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