Refinance Mortgage

I hear this alot but don’t fully understand the process that led to the boom in sub prime mortgages and banks profits.

How did the banks make money from selling packaged up sub prime mortgages to investors, and why would the investors purchase them?

Where these investors the likes of Goldman Sachs and Lehman Bros?

Well, it is complicated, but basically, the loan is discounted. In other words, the loan that is made has an amount of interest that will be paid over the term of the loan. This interest is the profit a company can make.

For example, if you made a loan for $50,000 and over the term of say 10 years, you pay back $75,000 then there is a $25,000 profit. The banks and mortgage companies would sell the loan to the investors for this amount and a fee of say $2,000. Now, the investor will make a profit of only $23,000. The bank basically makes $2,000 for putting all the paperwork together and the investor makes $23,000 for the use of their money over the next 10 years.

If the mortgage is defaulted, then the investor has to deal with selling the home, covering the costs of that foreclosure and etc. The bank however, has already made their $2,000 profit for doing the paperwork and is now moving on to the next customer.

I hear that if a bank goes under other banks will buy these mortgages. But with so many mortgages exceeding values of homes, many banks might not want to buy the mortgages. What would happen if a bank goes under, and no one wants to buy their crappy mortgages?

It would not happen. Some other lender would purchase the mortgages, simply because there is value there. No bank has ALL crappy mortgages. Another lender(s) will analyze the quality of the ‘paper’ and make a decision what the entire package is worth, and would purchase same, perhaps for less than the actual outstanding amount.