The Short Answer
Chances are that your loan will be sold after you close, meaning that the lender you used will probably sell the loan in a "bundle" with other loans to institutional investors. This will not affect you at all - your payment and all the terms stay the same.
The Long (in-depth) Answer
Here's a great article submitted to us by Patrick Collins of First Savings Mortgage explaining how a loan is "sold" and what happens to it once it's purchased by institutional investors. The article also addresses the market situation as of August, 2007. This article was written by Larry Baer:
I've been asked to comment about the crisis of confidence in the non-conforming sector of the mortgage market. Since the starting point of this entire discussion may be different for each of us predicated on our mortgage experience — I've decided to begin at the beginning and go from there.
Let's first take a look at where, how, why and from whom the capital to fund these loans flows. I think it is critically important to understand that mortgage capital sources (big money-center banks, investment banks, hedge funds, pension funds, the Treasury components of foreign governments, wealthy individuals, etc) have never once invested in a mortgage-backed security out of the goodness of their heart - out of a desire to help provide housing for America. Nope - their sole purpose in buying mortgage-backed securities is to generate the biggest bang for their buck for the least amount of risk. These capital sources will invest in green widgets if green widgets generate as much or more return on the dollar with a risk profile that matches or falls below the risk profile of mortgage-backed securities.In general these investors have a couple of performance benchmarks they are committed to. Like any other investor, they are first and foremost keenly interested in the return OF their capital and secondly they are interested in the return ON their capital (a borrowed one line liner from the late western humorist Will Rogers). These capital sources tend to be intently focused on generating a total rate of return of 150 basis points or more above a targeted rate of inflation - the higher the inflation adjusted rate of return with the least amount of risk the better.
The safest but most limited returns are generated from investments in obligations underwritten by the full faith and credit of the United States government - bills, notes and bonds. These debt obligations carry credit quality ratings of AAA - signifying to the investor that there is little chance the creditor (in this case the government) will fail to make remittances of both the principal and interest to the investor. Treasury obligations are considered the benchmark for a riskless rate of return primarily because Uncle Sam has the power to either tax or to print money to insure timely payments to his creditors.
Conforming mortgage-backed securities (Fannie Mae, Freddie Mac, and Ginne Mae) don't carry any credit risk to speak of either — because the borrower of each individual loan contained in a pool of conforming loans pays a guarantee fee as part of each month's remittance. Don't confuse guaranty fee with private mortgage insurance. Private mortgage insurance protects the lender against loss of a portion of the principal amount of the loan in case of foreclosure - the guarantee fee assures the investor holding a mortgage-backed security (an instrument collateralized by a number of individual mortgage loans) that all principal and interest remittances will be made.
This guarantee fee is imbedded in the note rate of the each individual loan and may be as small as 6 basis points for a 30-year FHA or VA loan. The guaranty fee on conforming loans will vary from lender to lender and product to product but will seldom exceed 25 basis points. This guaranty fee is collected by the loan servicer and transferred to a designated trustee to hold as a credit enhancement for the capital source (big money-center banks, investment banks, hedge funds, pension funds, the Treasury components of foreign governments, wealthy individuals) that assures the investor they will receive the repayment of both their principal and accrued interest. It's a sweet deal - and with that guaranty fee, these conforming mortgage-backed securities carry the same credit quality as an obligation of the United States Government - AAA. Only the highest quality debt obligations are rated AAA - a designation which implies the issuer's capacity to pay interest and principal is extremely strong under virtually any market condition.
Because there is little risk that the principal amount of the investment together with accrued interest will not be returned to the capital source - conforming mortgage-backed securities carry rates only 150 basis points or so higher than matching debt obligations of the United Sates government. The reason note rates are higher than equivalent government debt obligations is because repayment of mortgage-backed security depends on the flow of payments from individual borrowers rather than the taxing and money printing capacity of the government.
This arrangement benefits everyone involved:· The mortgage lender has very quickly received a disbursement from the bond dealer from the sale of the mortgage-backed security which enables the mortgage lender to immediately use this money to originate more loans.· Home buyers benefit from lower mortgage rates created by global demand for these mortgage-backed securities which in-turn provides an steady supply of money to meet loan demand.· The capital sources, those whose money makes all this work in the first place, benefit from a higher rate of return than available from government debt instruments while being fully protected from losses even if massive defaults on the underlying mortgages were to occur.It's a sweet deal all the way around.So what has gone so wrong in the non-conforming sector of the mortgage market? Back to the Future.
As mortgage interest rates tumbled to their generational lows during the first few years of the new century the total returns to investors in the mortgage market fell as well. Investors banged on Wall Street to figure out a way to provide more return for the buck. Somebody struck on the idea of making loans to people with poor credit histories as a way to increase loan demand and ultimately to increase the flow of non-conforming mortgage-backed securities.
To compensate for the elevated credit risk the borrower presented, it was decided the note rates on these loans would be at least 200 basis points higher than the note rates offered to grade A borrowers. The thinking was even though a number of the these borrowers would default on their mortgage - the higher fees paid at closing and the higher note rates would more than compensate for the loss. Even if the loan went into foreclosure the capital source had nothing to fear because the property would sell quickly at a price equal to or greater than the original sales price -- essentially eliminating the risk of loss of principal.
During the housing boom of 2003 through 2005 capital sources profited handsomely from returns far superior than they could generate in the conforming mortgage market. Initially these subprime loans performed so well that credit rating agencies (S&P, Moody, Fitch) rated some subprime and jumbo loan securites as high as AA - just a notch below a perfect score of AAA. These high credit ratings allowed even Blue Chip conservative investors to join the the mortgage feeding frenzy -- and everything worked perfectly. As demand for these securities soared, credit standards continued to erode as the pool of prospective credit worthy borrowers shrank. Eventually all it took was a desire to own a home - no need to worry about verifying income, providing downpayment or money for closing cost -- it was all taken care.
Things began to go significantly awry toward the end of 2006 as borrowers began to default on loans at a rate far in excess of what was anticipated. In certain geograhic areas of the country property values began to plummet as foreclosure rates syrocketed. The fabric of the subprime mortgage-backed securites began to fray and then gave way entirely.In short order investors began to experience delayed remittances of interest followed in short order by notices that their principal was lost as well. To compound matters the credit ratings agencies reversed themselves and dropped the credit ratings of subprime securities to junk bond status - a level well below the minimumcredit standard authorized as portfolio quality for many mutal funds, insurance companies, money-center banks, Treasury departments of foreign government, and many other investors. As if somebody had just yelled "Fire!" in a crowded theater, the panicked rush for the exits was on - and there was no doubt some where going to be severely injured in the stampede.As day after day of senationalistic journalism in every mass media outlet bombarded the investment community — the emotion of fear completely over-ran the non-conforming mortgage market. Like a child that used to pet every dog they saw - investors bitten by one dog have now decided that all dogs bite. This current period of all encompassing fear leaves no room at this juncture for rational "cause-and-effect" discussion. Capital for non-conforming mortgages will continue to be available but at rates and terms massively different that available just days or a few weeks ago.Markets are very efficient in correcting imbalances. The process is brutal and financial fatal for some. The pendulum has swung to an extreme in terms of pricing in risk. Within 90 to 180 days that pendulum will likely begin the slow process of swinging back to more rationale levels.Look for the conforming mortgage market to continue to draw significant amount of investor interest. There is nothing like a essentially riskless investment with a rate of return higher than a corresponding Treasury obligation to serve as safe harbor for those beat up by the rout in the non-conforming mortgage shakedown.Mortgage-backed securites, how they are formed and how they operate.
A short synopsis
- Pools are created by lenders. For example, a mortgage lender may originate 100 home mortgages in which each buyer agrees to pay a fixed interest rate of 6.5% for a 30-year term. The lender (who must be an approved issuer of Fannie Mae, Freddie Mac or Ginnie Mae securities) obtains a guarantee from the GSE and then sells the entire pool of mortgages to a bond dealer in the form of a mortgage-backed security.
- The bond dealer then sells the mortgage-backed securities to an investor (big money-center banks, investment banks, hedge funds, pension funds, the Treasury components of foreign governments, wealthy individuals, etc), paying 6.0% in this case, backed by the income stream from the underlying mortgages.
- The original lender or a designated servicer continues to collect payments from the home buyers, and forwards the money to a trustee who pays the holders of the bonds. As these payments come in, the trustee pays the principal which the home owners pay (or the amount that they are scheduled to pay, if some home owners fail to make the scheduled payment), plus 6.0% interest to the investors. The difference between the 6.5% interest rate paid by the home owner and the 6.0% interest rate received by the investors consists of two components. Part of it is a guarantee fee (which Fannie Mae, Freddie Mac, or Ginnie Mae gets) and part is a "servicing" fee, meaning a fee for collecting the monthly payments and dealing with the homeowner.
- If a home buyer defaults on payments, the GSE (government sponsored enterprise) pays the accrued interest as specified by the bond coupon together with the scheduled principal payment each month to holder of the mortgage-backed security, until the property is foreclosed. If (as is often the case) there is a shortfall (meaning a loss) after a foreclosure, Fannie Mae, Freddie Mac or Ginnie Mae still makes a full payment to the investor using guarantee fee funds if necessary. If a home buyer prematurely pays off all or part of his loan, that portion of the bond is retired, or "called", the investor is paid accordingly, and no longer earns interest on that proportion of his bond.