Selling Loans

• Historically, banks retained mortgages, but in recent decades as of 2011 banks have increasingly opted to sell mortgages because doing so reduces the level of risk to which banks are exposed. Interest rates fluctuate on a daily basis. A bank with a large portfolio of low-interest mortgages may experience financial problems if interest rates rise because the bank's own borrowing costs will rise while its income remains fixed. Selling mortgages to investors protects banks from interest rate risk because banks end up retaining only small numbers of loans with different interest rates.
  
  

Profit

• A mortgage provides a bank with two opportunities to make money: upfront profits and long-term revenue. Many banks charge an origination fee for most types of loans. Banks also charge underwriting fees, application fees and document preparation fees, all of which generate revenue.
  
  When a bank sells a loan, it receives a purchase fee from the company that buys the loan. The company that buys the loan enjoys the long-term revenue that comes in the form of interest payments. A bank makes a profit on every loan that it sells even though it does not receive the interest income.
  
  

Boom

• Investment firms bundle mortgages into investment funds and then sell bonds that are secured against those funds to investors. When mortgage rates are low, the yields on these bonds are low, so investors who are seeking higher levels of return develop an appetite for mortgage-backed securities with higher yields.
  
  Banks charge the lowest interest rates to people who have good credit, so in order to write loans with higher yields, banks lower underwriting standards and write high-interest rate loans for people with poor credit. The lowering of underwriting standards enables banks to write more loans and therefore create more profits by selling those loans.
  
  

Recession

• During a recession, investors have less money to spend, which means the demand for mortgage-backed securities begins to drop. Additionally, foreclosure rates increase during recessions, which means mortgage-backed securities lose value and bonds tied to high-risk mortgages become especially vulnerable to price drops. Consequently, banks raise underwriting standards because the market for high-risk loans disappears. Banks still continue to generate profits from selling small numbers of high-quality loans, but profits from mortgage sales are much less than during an economic boom due to the reduced volume of mortgage sales.