Consumer Law

Mortgage Securitization - What Is It?

By M. Stan Herring

One issue that comes up in almost all Alabama foreclosures is whether the loan (the note) has been held by the original bank or mortgage company or instead if it has entered the somewhat mysterious world of mortgage back securitization?

We begin a series on this issue today and will add original posts and also newsworthy items to this "category" on our blog.

So, what in the world is "securitization" and what does it mean to me? In this post we will start to answer the first part of this question - what is it - and in future posts we will get to the personal part which is what does it mean to me....

Here is a basic definition that will work for us.

Securitization is when a large number of assets (for examples home loans) are bundled or "pooled" together into a separate legal entity which then sells investments (or securities) to investors who put money into this separate legal entity.

So here's an example to start to put all of this in context.

A local bank could loan you the money to buy a house. You would sign a "note" which lays out the terms of the loan (30 years, 6 % interest, $150,000, etc) and the bank would keep that note. Every month you made your payment the bank would make its return on the loan - the interest payments.

But if you missed a payment, the local bank would miss that money coming in that month. If you went into foreclosure the bank would own the house instead of getting its payments.

If the bank asked Joe Blow to invest in this loan, he would have the same risks and limitations that the bank had. That is, long term (30 years) with the possibility that the loan would not be paid off. Not a very liquid investment.

So, here is where securitization comes into play. An investor does not invest directly into the loans but instead into the separate legal entity which is normally a trust established under New York law.

OK, what difference does this make? Here's the deal. The trust will have hundreds or thousands of residential loans. The trust will also make different investment options available. Maybe you want a higher rate of return and are willing to take on a higher risk? You can invest that way. Maybe you want a short term investment - that's available. Maybe you want to be very safe in your investment - supposedly the trust will allow you do this. All of these options are available even though the trust is full of 30 year - fixed 6% - $150,000 loans.

So going back to the original loan - that loan is normally immediately sold to the trust so the bank that you borrowed the money from does not own the loan. The trust does. Or supposedly it does.

We will pick up on some of the implications of securitization in future posts but for now we wanted for all of us to be on the same page as to what it means to have a loan that is involved in the securitization process.

If you live in Alabama and would like to talk with us about this issue or any other issue, please feel free to call us at 205-879-2447 or fill out our inquiry form on our website.

Full post as published by Alabama Consumer Blog on November 16, 2009 (boomark / email).