Back in the “old” days, if you wanted a home loan you walked into your local bank and completed an application for a mortgage.  The Bank used their guidelines and made the decision on your approval.  Once approved, the Bank funded your mortgage loan with their own money and kept your mortgage loan on their books.  And they accepted your mortgage payments each month until the loan was paid in full.

While this is convenient for the consumer, it wasn’t optimal for banks as they only have so much capital to lend.  These days, it’s about OPM – other people’s money…ordinary people’s money.

If that has you bewildered, read on.

When mortgage loan documents are signed, the mortgage typically is funded by the company who has originated and closed the transaction for the borrower.  From there, the mortgage moves through multiple channels as illustrated below.

Most likely, the mortgage will be/was packaged and  “pooled” with a bunch of other mortgages and then sold to one of the 3 stooges (more properly labeled “issuers”) -  Fannie Mae, Freddie Mac, or Ginnie Mae.

But you don’t make your checks out to Fannie, Freddie, or Ginnie, right?

That is because  the servicing rights of your mortgage will be sold to a servicer…usually one of the big 5 – Wells Fargo, Chase, Citi, GMAC, and the biggest….Bank of America.

While you may be making mortgage payments to the original lender, most people make their payments to a servicer.  A servicer is a company that is “servicing”  your mortgage – they receive your monthly mortgage payments and appropriately apply to principal, interest, mortgage insurance and your escrow account for taxes and home owners insurance.  The servicer very rarely “owns” your mortgage however they do receive a fee for processing payments and providing customer service to you.

The issuers, Fannie, Freddie, and Ginnie,  pool mortgages that have been originated by banks and brokers and sell them to Wall Street.  The Street bundles, then slices and dices the mortgages into tranches to sell as securities, called Mortgage Backed Securities, to investors.  Each security represents a small ownership, not in your specific mortgage, but in the pool of which your mortgage is one of many.

Mortgage Backed Securities are sold in the bond market alongside Treasures.  In fact, they compete for the same investment dollar.  Bonds are considered a “safe haven” for investors as they provide a fixed rate of return.  Investors, usually institutions, are looking for a safe investment yet one that returns a nice yield.  Often these securities land in our retirement funds or could be a piece of an investment portfolio.

By purchasing the mortgages from lenders, Fannie, Freddie and Ginnie enabled those lenders to turn around and make more home loans.  Then Fannie, Freddie, and Ginnie turn and sell those mortgages as securities, freeing themselves so they have the ability to buy new pools from lenders and continue the cycle.  And so it goes…round and round.

There are some exceptions, one of which is Jumbo mortgages.  If your loan amount is above $417,000, it does not conform to Fannie Mae and Freddie Mac guidelines.  These mortgages are called Jumbo mortgages and are purchased by portfolio investors.

The buying and selling of mortgages is called mortgage banking.  As you can see, it is the backbone of the industry.