Understanding Why Mortgages Change Hands
Are you one of the many homeowners who has opened up a letter from your mortgage provider and read that your mortgage loan has been transferred? Did it prompt an increase in your heart rate and cause you to worry what this means for you and your mortgage?
First of all, try not to become too concerned. What many of us do not realize is that a mortgage can be transferred not just once but multiple times over the term of a loan. The majority of borrowers never even know it has happened.
In fact, it is only under certain circumstances that your lender is under an obligation to tell you that your mortgage has been sold.
Yes, this can be a worry, but don’t panic. Your mortgage being transferred will not affect the terms of your loan in any way. You will have the same repayments, interest rate, and loan conditions as you did when you signed your mortgage agreement.
So, you may be asking yourself, if nothing changes for me, why do mortgage loans get transferred?
To understand why a lender might transfer your mortgage, first, it is crucial to change the way we think about our home loans.
Your Mortgage Is A Financial Product
When you apply for a mortgage, you will no doubt research different lenders. Then you will evaluate a wide range of loans and their terms and conditions before choosing the best mortgage for you. Along the way, you probably asked potential lenders a bunch of mortgage questions to determine who will be best for your financial circumstances.
Without a doubt, you’ve probably learned quite a bit along the way. The process of choosing a lender and your mortgage has concluded. The lender has accepted your application. It feels like a relationship between the two of you.
Wrong. To lenders, mortgages are just another product. Products which make a stable profit, make them valuable items to buy and sell.
Welcome to the secondary mortgage market.
How A Mortgage Can Be Profitable
By submitting a mortgage application, and if successful, signing a mortgage agreement, a borrower creates a product which can be bought and sold on the secondary mortgage market.
This market exists because mortgages can be profitable in three ways:
- Origination fees: When you apply for a mortgage, you will be charged an origination fee. This fee is levied to cover the costs of your application. In reality, banks make a profit on origination fees, so the simple act of leading a borrower through the application process is profitable.
- Servicing: Once you have your mortgage, a proportion of your monthly payment goes towards the administration of your loan. Doing so includes distributing the money to the correct recipients, recording your payments, sending you statements, etc. The company that carries out this work is the mortgage servicer, and they make their profit from the admin portion of your monthly payment.
- Interest: The interest you pay each month goes to the mortgage “owner.” When a lender sells your mortgage debt to another party, the bank is paid a percentage of that loan amount, and the buyer makes their money over the long-term, through the interest payments.
When a lender transfers your mortgage, they might transfer:
Only The Debt
Your lender may choose to sell only your mortgage debt. The amount you owe, and consequently the profit from the interest on the debt, will become the property of someone else. Meanwhile, your lender retains the right to service your debt and will continue to make money through the administration of your mortgage.
In this scenario, nothing will change for you, and you may not even be aware that your debt has been transferred.
Only The Servicing
Another possibility is that your lender will keep the debt portion of your mortgage but will choose to transfer the administration of the debt to another company. In this case, the new company becomes what is known as your mortgage servicer.
In this situation your original lender and the new mortgage servicer should both contact you in writing, to let you know what has happened. When this happens, both companies have several legal responsibilities, and you have federally regulated rights.
Both The Debt And The Servicing
The third possibility is that your lender will sell both the debt and the servicing of your mortgage to another organization. In this case, you will be informed, in the same way, you would if only the servicing had been transferred.
Some lenders choose to make money as a mortgage originator but do not want the ongoing work of servicing the loan and carrying the debt.
What Is A Mortgage Originator?
A mortgage originator is the person, or organization, which takes you through the mortgage application process. In some cases, this is a mortgage broker, and in other cases, it is the lender themselves.
It works like this:
A potential borrower is looking for a mortgage. They, generally speaking, have two options.
- They can research different lenders and loan products and then apply directly to their chosen lender. The lender makes money at this stage through the origination fees.
- The borrowers can go to a mortgage broker. The broker will process their application in the same way as a lender will. Then, once the application has passed all of the appropriate checks, the broker will connect with a lender, who will provide the money for the loan at closing. Mortgage brokers typically have access to numerous mortgage programs. The broker makes their money through origination fees, and possibly through a commission from the lender.
The lender now owns the loan and can make money by:
- Servicing the loan and selling the debt
- Holding the loan, making money on the interest and selling the servicing
- Selling both the servicing and the debt
- Keeping both the servicing and the debt.
Other lenders chose to make their profits through the servicing of mortgage loans. In this case, they are the mortgage servicer. There are many differences between the role of a mortgage originator and a mortgage servicer.
What Is A Mortgage Servicer?
A mortgage servicer is a business which takes care of all of the administration of your loan. When we think of a mortgage payment, we believe that part of the payment goes towards paying down the principal and the other part of the fee is interest on the amount owed.
In reality, it is a little more diverse.
Yes, one piece of your monthly mortgage payment goes towards paying down the amount you owe.
The other slice of your payment is not just interest on your loan. This payment is actually broken down into interest, a servicing charge, and, on some occasions, other things such as Private Mortgage Insurance (PMI). The serving fee pays for the administration of your mortgage and is paid to the mortgage servicer.
The mortgage servicer is responsible for:
- Receiving your mortgage payment.
- Recording your mortgage payment against your account.
- Distributing the money to the correct people, i.e., the insurance company, loan owner, etc.
- Making a note of all of these payments, where and when they are made, and keeping track of remaining balances.
- Sending the borrower a monthly or annual mortgage account statement, whichever was agreed upon when signing the mortgage documents.
- Providing customer care to the borrower. This could be for basic queries, to support borrowers who are running into financial difficulties, or for any other borrower interaction.
Finally, the bank or other lenders may choose to make money from the interest on the loan. In this case, they retain ownership of your debt. Each month the interest on the debt is paid to them via the mortgage servicer as well as the piece of your payment allocated to paying down your debt.
Why Are Mortgage Loans Transferred?
So, why do lenders transfer mortgage loans? Surely it would be better to keep the mortgage and make all of the profit from all three streams; the origination fees, the servicing, and the interest?
In theory, yes.
However, there are two reasons why lenders transfer mortgage loans.
To Free Up Capital
Across the country, lenders approve approximately 580,000 mortgages a month. These loans are long-term financial products. Today, the average mortgage term is 30 years, and this is a long time for the lender to wait to recoup all of their money.
Not only that but, more importantly, the lender would run out of capital and would have to stop issuing mortgages.
It works like this.
A lender has $20 billion in capital, with which they can approve mortgage loans. As a consequence, this lender can approve 57,142 loans of $350,000 before they run out of money to lend to other borrowers, for additional mortgages.
You can see the problem. Without selling the mortgage debts, lenders around the US would quickly run out of money and would then be unable to approve any new mortgages.
To Make A Profit
Even if lenders had a limitless supply of cash on hand to extend mortgages, there is profit to be made by selling mortgage loans.
For example, let’s say a lender makes a 1% profit by selling mortgage loans. These sales are not made on a single loan by loan basis. A large number of mortgages will be bundled together and sold together as one lot so a lender will sell, perhaps $20 million worth of loans at once.
By selling $20 million worth of loans, at a 1% rate, the lender has another $20 million to extend new mortgage loans PLUS they have made $200,000 in the process.
If a lender did this once a month, they would make $2,400,000 a year by selling their mortgage loans. In the meantime, if the lender had kept those loans, and the average interest rate was 5%, the lender would make $1,00,000 in interest.
Even if they retained the mortgage loans and the servicing, the amount the lender would make doesn’t come close to the profit to be made on the secondary mortgage market.
Who Buys Mortgage Loans?
So now we know why your mortgage loan may be sold, we’ll take a look at who may buy it. After all, it would be good to know exactly who you owe your money too wouldn’t it?
Fannie Mae and Freddie Mac purchase the majority of the mortgage loans on the secondary market.
Freddie Mac is the more familiar name of the Federal Home Loan Mortgage Corporation (FHLMC). After buying mortgages, Freddie Mac bundles multiple loans together and sells shares in those bundles on the financial markets as “Mortgage Backed Securities.”
The FHLMC makes a guarantee that investors who buy these shares will receive a guaranteed payment each month, and the US Government Treasury Department backs this guarantee.
Fannie Mae is the Federal National Mortgage Association, and like Freddie Mac, they also buy mortgages, bundle them together into mortgage-backed securities and then sell shares in the MBS on the financial markets.
Again, as with Freddie Mac, investors receive a monthly payment, and this is backed by the US Treasury Department.
The main difference between the two is that Fannie Mae buys mortgages from the larger banks and Freddie Mac purchases loans from smaller lenders.
Shares in the Mortgage Backed Securities of both Freddie Mac and Fannie Mae are primarily pension funds, insurance companies, securities dealers, investment funds, and other financial institutions.
Has There Always Been A Secondary Mortgage Loan Market?
The government founded Fannie Mae and Freddie Mac in 1970. Before this, only the larger banks had enough money to extend thousands of mortgages and hold them for the length of the loan. As a result, mortgages were difficult to obtain, and there was little competition in the mortgage market. This lack of competition led to higher interest rates and fees.
By establishing Fannie Mae and Freddie Mac, the government created a system where banks can sell the mortgages they sell and free-up additional capital, as consequence lenders can then extend more loans, to more borrows. This stimulates competition between lenders, driving down interest rates, and allowing more people to purchase their own homes.
Not only that but a thriving housing market boosts the entire economy. Depending on where you source your information, Real Estate contributes between 13% and 18% of the US Gross Domestic Product.
Lenders and borrowers have very different attitudes towards mortgage loans. For borrowers, a mortgage is a personal thing, but for lenders, your loan is a financial product which can be bought and sold on the secondary mortgage market.
The government created the secondary mortgage market to provide a mechanism by which lenders can transfer mortgage loans and thus free-up more capital as a consequence; lenders can then grant more mortgages to more borrowers. This is good for borrows because it makes mortgages easier to obtain, and the additional competition drives down interest rates and fees. Not only that but all of this economic activity makes a significant contribution to the US economy.
By transferring mortgage loans, lenders not only have more money with which to authorize more mortgages, but they can make a profit when they place bundles of mortgages for sale on the secondary market.
Additional Helpful Mortgage Resources
- What a lender will need to give a mortgage – see what you will need to provide a lender for them to grant you a loan. It should be understood that different types of loans require various documentation. See a list of all the requirements for the principal loan programs, including conventional, FHA, VA, and USDA, among others.
- Advantages and disadvantages of an FHA 203k loan – are you planning of using a 203k loan to renovate a property? Before doing so, make sure you know the pros and cons of this type of mortgage.
- How interest rates impact what you pay for a home – we are in one of the best interest rate environments for a real estate purchase in decades. See how the interest rate you receive on your loan can influence what you pay for a house.
- Rolling closing costs into the loan with an FHA mortgage – learn what you need to know about rolling your closing costs into the final mortgage when purchasing a home with an FHA loan.
Use these additional mortgage resources to make sound financial decisions when buying a home.
About the author: The above article on why mortgages get transferred was written by Geoff Southworth. Geoff is the creator of RealEstateInfoGuide.com, the site that helps new homeowners, investors, and homeowners-to-be successfully navigate the complex world of property ownership.
Geoff has been a real estate investor for the past eight years and has had experience as a manager of a debt-free, private real estate equity fund, as well as a Registered Nurse in Emergency Trauma and Cardiac Cath Lab Care. As a result, he has developed a unique “people first, business second” approach to real estate.