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This is a two part question:

1) I understand that there are certain mortgage loans that when originated by banks can be gathered up into pools and then "sold" to investors, and that these pools are backed by Ginnie Mae, in the sense that, if the borrowers are unable to make payments, and the banks that originated them are also unable to make payments, then Ginnie Mae would step in and make the payments.

My first question is about the banks. What incentive do they have to gather up the loans in pools and sell them to investors? Because the payments made are not ending up in their pockets, but that of the investors instead.

2) Secondly, I've read that, in this process, Ginnie Mae collects a fee (of a max of six basis points). Who is this "fee" levied upon?

I hope my questions aren't too naive and simple to understand. Thanks!

Kat
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ricksanchez
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2 Answers2

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Say I can lend money at a 10% rate. I lend you $10,000 and the note is for $11,000 due in one year. But, the next day, I can sell the note for $10,100, the buyer willing to get a return of 8.9%. ($11K/$10.1K). Why would I lend that $10K for a year, when I can turn over the loan and make 1% in a day?

The mortgage is more complex, of course. But the concept is similar. Underwriting the loan and selling it into a package (CMOs or Collateralized Mortgage Obligations) lets a small bank help their customer get the mortgage, but not have their funds tied up for decades. At the other end, are investors who can get a return on their money closer to the rate on long term loans.

The concept itself is sound so long at ethical underwriting is maintained, i.e. 20% down, 28/36 debt to income limits, etc. The market blew up when this was ignored, not because the premise was faulty.

The 6 basis points are skimmed from the payments homeowners make for the money then paid to the CMO holders.

JoeTaxpayer
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Legal scamming, basically. That is speaking about the pooling part, not the "selling a debt" part. There are good reasons for doing that.

When you pool up mortgages, you also hide the details of individual ones. That way you can begin to play statistics games and present averages of the size, risks and other factors. Just picking your average (mean, medium, mode? and there are more...) carefully can make the bundle look better than it is. And once the pool has been repackaged a few times, risky loans that nobody would want on their portfolio can become entirely invisible. Now find someone stupid enough to buy into an opaque financial construction and ... profit.

That is not exaggeration, that is exactly how the financial crisis happened. Not much has changed since then.

Tom
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