How Do Banks Sell Loans to Investors?

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Banks Issue Loans

The loan process begins when an applicant approaches a bank, either on his own accord or in response to a solicitation, and requests a loan. In response to the application, the bank obtains identifying information from the prospective borrower and performs a credit check to determine the likelihood that the applicant will repay the loan. In most cases, the bank also obtains information on the applicant’s income, assets and other outstanding debts. With all available information collected and considered, the bank decides whether the borrower is likely to repay the loan, the level of risk the bank is willing to assume if the borrower does not repay and, ultimately, whether to grant the loan. If the bank elects to approve the loan application, it notifies the borrower and funds the loan. Once the bank has funded the loan, the outstanding debt becomes an asset on the bank’s ledger.

Banks Bundle Assets for Sale

Once the bank has approved and issued a loan, and added the outstanding obligation to its asset sheet, it presents the asset for sale to its investors. Depending on the bank and the market, the lender may offer the loan for sale by itself or bundled with other outstanding obligations. In some cases, especially in markets that cater to smaller investors, banks may sell the loans in fragments that allow dozens, hundreds or even thousands of investors to contribute small amounts and purchase a portion of the loan. When banks offer the loan for sale, they often list critical factors about the loan including its interest rate and the borrower’s credit rating; investors use this information to determine whether to purchase the loan. In some cases, potential investors may not have much time to decide; according to the United States Government’s Treasury Direct service, the sale of loan investments, known as securities, may take place in a trade market, online exchange or in an auction environment.

Investors Free Up the Bank

Once a bank has sold a loan, it may use the funds it receives from investors to initiate new loans. In most cases, the bank simply accepts the funds from the investors and uses them to fund new loans, starting the entire process over again. In addition to helping the bank initiate new loans and perpetuate its operations, the ability of banks to sell loans to investors also helps relieve the bank’s risk associated with lending money. If the borrower falls behind, the bank may pursue collection activities, but the investor who purchased the loan bears the loss in case of default. Since the bank gets its entire money, plus a portion of the interest rate, when it sells a loan, the bank also realizes an immediate profit from the sale.

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