A large bull seems relaxed as a herd of cows grazes near by at the Estes Park Public 18-whole Golf Course. With the rut at peak, several large bulls have divided the More »
A big bull wanders the Lake Estes 9-hole Golf Course. The golf course seems to be a favorite hang-out for elk, when they gather in the autumn for they annual rut. More »
Snowy peaks tower over the golden trees in downtown Estes Park.
There is a good chance you are financing your own home loan. You are borrowing from yourself (and paying yourself back) through the mechanics of the mortgage market.
The mortgage market exists to mitigate risk.
People assume mortgage risk refers to whether or not the customer is going to pay the lender back. Yes, of course that’s a risk (repayment risk), but that consideration is already accounted for, included in the statistical analysis used to develop each loan program. The real risk is in interest rate, or market risk. That’s where substantial money can be lost.
Let’s take a look at this by using an example: consider a $100,000 loan at 3.0% fixed-rate interest. (For this illustration, let’s just use simple interest). Next year, for whatever reason, interest rates jump to 6%. Does the lender who is holding the $100K mortgage still have an asset worth $100K? In a 6% percent market, who would buy this loan?
$100,000 is still worth $100,000, however, this money has an interest rate tethered to it, so it has an inherent rate of return. In the 3% market, the return is $3,000 annually to the lender, but in a 6% market, the return should be $6,000, but it’s a 3.0% fixed-rate loan. The loan is now worth half as much.
On one loan, the lender can absorb these fluctuations (after all, if the rate lowers, the lender will be making a better rate of return). But what if the lender has $2 billion in loans out and this happens? That’s a loss of $1 billion in asset value – it’s hard to stay in business this way.
So how do lenders mitigate this risk? The answer is securitization: the mortgage-back securities (MBS) market.
Without MBS, you would never get a fixed rate loan. In other parts of the world without a mortgage market, there are only adjustable-rate mortgages that pass on the ups and downs of the financial market to the consumer directly. The MBS creates a climate stable enough to sell fixed-rate loans.
This is how it works: first, the borrower seeks a loan from the originator, who funds it through a mortgage bank. To mitigate the risk inherent at that level, the loan is passed over to an investor (or servicer), who services the loan: collects payment, calculates pay-off amounts, etc. Many borrowers assume that the company servicing the loan now owns the loan, but they don’t. They are similar to a superintendent in an apartment building; the mortgage company still owns the loan – the servicing company owns the debt. After taking its cut, the servicing company returns the full payment collected back to the lender.
Then, the loan is passed on to Fannie Mae or Freddie Mac; they collect loans from all over the country to create large pools of mortgages. These companies also know that due to volatility, they can’t hold onto the risk for long, so they package them and sell them – typically in 30- to 60-day bundles (that’s why you have 30- and 60-day lock periods when shopping for a loan).
Then the risk is moved to Wall Street, where these pools are underwritten and securitized with specific performance targets as mortgage-backed securities, included in many 401ks and other investment portfolios.
So who are these sold back to?
People like you and I, we are the ones actually assuming the risk. If you look at your retirement packages or 401k, you will see Fannie Mae or Freddie Mac bonds. The same people who are borrowing the money are lending it.
So by being a vibrant consumer and supporting a healthy market, you are not only making your own low-interest, fixed rate loan possible – you are financing it yourself.
A large bull seems relaxed as a herd of cows grazes near by at the Estes Park Public 18-whole Golf Course. With the rut at peak, several large bulls have divided the area’s cows, while smaller bulls either keep to themselves or attempt to pick off cows around the edges of the herds.
A big bull wanders the Lake Estes 9-hole Golf Course. The golf course seems to be a favorite hang-out for elk, when they gather in the autumn for they annual rut.
A photographer from New Jersey snaps the Forest Canyon and surrounding peaks