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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This happens all the time, although it’s really rare for a bank to sell an individual loan. They’re typically sold off in blocks as a “Mortgage Backed Security,” and investors buy those securities.
Why would a bank do this? (1) the bank makes money from origination fees and other costs of the loan which are paid by the borrower; (2) banks are limited in how much debt they can have on their books relative to their deposits — if they sell off the mortgages, then the amount of debt that they have falls, and they can make more loans. So, the bank’s approach is: (a) issue a mortgage, collect origination fees, (b) sell the mortgage back off, (c) go back to (a).
Why would an investor do this? Because it’s an investment, and it’s fairly low-risk. They get a string of future payments that, they believe, is going to be worth more than the money that they pay in. And, if they want to, they can then sell that investment in the future.
Note that the investor is different than the loan servicer. A loan servicer is responsible for collecting payments from borrowers, taking care of escrow, sending out statements and so on. They do this under a contract (indirectly) with the investors.
Finally, note that the price that people are willing to pay for your loan will change over time so that your loan may be worth more or less to an investor than your payoff value. Let’s say that you borrowed money in 2017 at 3% that required you to pay $1,000 a month for the next 30 years,. Then, 5 years later, your best friend borrowed money in 2022 at 6% that required him to pay $1,000 a month for the next 25 years. To an investor, your mortgage is worth just about as much as your friend’s, even though your principal amount is significantly higher. Why? Because it generates exactly the same cash flow to the investor: $1k/month for the next 25 years.
This last part is interesting: technically, if owed, say, $100,000 on a mortgage that paid $1000/month at 2%, you ought to be able to go to whoever owned that mortgage and say something like “Look, I know my mortgage isn’t worth $100,000 to you right now. How about if I buy it from you for $90,000? That’s a win for you AND a win for me.” But, for various reasons, that’s nearly impossible.
[The financial meltdown of 2007/2008 was caused, in part, by Mortgage Backed Securities. There have been a number of reforms, both governmental and at lenders/investors intended to prevent that from happening again.]
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