How do/did banks make money selling packaged up mortgages to investors?
August 3rd, 2009 by Lenny
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?
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Tags: alot, banks make money, boom, goldman sachs, investors, lehman bros, profits, sub prime mortgages
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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.