In the olden days, when someone wanted a home loan they walked downtown to the neighborhood bank and asked for one. If the bank had extra funds lying around and considered you a good credit risk, they would lend you the money from their own funds.
Generally, it doesn't work like that anymore. Most of the money comes from three major institutions:
- Fannie Mae (FNMA - Federal National Mortgage Association)
- Freddie Mac (FHLMC - Federal Home Loan Mortgage Corporation)
- Ginnie Mae (GNMA - Government National Mortgage Association)
This is how it works (for the most part):
Talk to a lender and apply for a loan. They do all the processing and verifications then once they release the funds to escrow (assuming escrow closes as well), you now own the house with that loan. You might be making payments to the company who originated your loan, or your loan might have been transferred to another institution. The institution where you mail your payments is called the servicer, but most likely they do not own your loan. They are simply servicing your loan for the institution that does own it. This transfer happens all the time!
Behind the scenes, your loan was packaged into a pool with other loans and sold off to one of the three institutions listed above. The servicer of your loan gets a monthly fee from the investor for servicing your loan. This fee is usually only 3/8ths of a percent or so, but the amount adds up. Some companies service over a billion dollars of home loans.
At the same time, one of the above institutions, whichever one packaged your loan into the pool, has received additional funds to make more loans to other borrowers. This is the cycle that allows institutions to lend you money.
Sometimes after Fred, Gin, and Fanni have purchased said loan pools, they will break them down into smaller increments of $1,000 or so, called mortgage-backed securities. They sell these mortgage-backed securities to individuals or institutions on Wall Street. If you have a 401K or mutual fund, you may even own some. Perhaps you have heard of Ginnie Mae bonds? Those are securities backed by the mortgages on FHA and VA loans.
These bonds are not ownership in your loan specifically, but a piece of ownership in the entire pool of loans. By selling the bonds, they are able to obtain new funds to buy new pools so lenders can get more money to lend to new borrowers.
And that is how the cycle works. Crazy right?
So when you make your payment each month, the servicer gets to keep their tiny part and the majority is passed on to the investor. Then the investor passes on the majority of it to the individual or institutional investor in the mortgage backed securities.
Now, there are exceptions.
For example, loans above $333,700 do not conform to Fannie Mae and Freddie Mac guidelines, which is why they are called non-conforming loans, or “jumbo” loans. These loans are packaged into different pools and sold to different investors, not Freddie or Fannie. They are then securitized and sold as mortgage backed securities.
This buying and selling of mortgages and mortgage-backed securities is called mortgage banking, and it is the backbone of the mortgage business.
Rather annoyingly complex, isn't it? Well, because of this busy process, you're able to buy that beautiful building you call home.