What is a Whole Loan?
A whole loan is a single loan offered directly to a borrower. Financial institutions often sell these loans in secondary markets to institutional portfolio managers and prominent agencies like Freddie Mac and Fannie Mae. By selling whole loans, lenders can mitigate their risk and quickly recapture principal amounts without waiting for the entire loan term of 15 to 30 years.
Key Takeaways
- A whole loan is a single loan extended directly to a borrower.
- Lenders often sell whole loans in secondary markets to manage risk effectively.
- Selling the loan allows lenders to reclaim the principal amount swiftly, rather than holding onto a long-term loan.
Appreciating Whole Loans
Lenders issue whole loans for various needs. They might include personal loans or mortgages, determined by specified terms post-underwriting. Whole loans usually reside on a lender’s balance sheet, which also carries the obligation of servicing them. The ability to sell these loans on the secondary market provides lenders with additional capital that can be reinvested into new loans, generating fresh income from associated origination and closing costs.
How Do Lenders Utilize Whole Loans?
Lenders often package and sell whole loans in highly liquid secondary markets. These secondary markets involve diverse buyers for various loan types. Notably, the mortgage sector maintains a robust secondary market with organizations like Fannie Mae facilitating such transactions. Through a process known as securitization, whole loans are either traded individually by institutional loan trading groups or grouped and sold as securities.
Lenders collaborate with institutional dealers to register their loans on the secondary market. This practice spans different loan categories including personal, corporate, and mortgage loans, appealing to active buyers such as loan portfolio managers.
Lenders can also bundle loans into securitization deals supported by investment banks, responsible for managing the portfolio’s packaging, structuring, and sales processes. These portfolios often consist of loans with similar traits, divided into various tranches rated for investor guidance. Freddie Mac and Fannie Mae set criteria for the loans they acquire, influencing how lenders underwrite mortgage loans to meet these guidelines.
Example: Selling a Whole Loan
Imagine lender XYZ sells a whole loan to Freddie Mac. XYZ stops receiving interest on this loan but obtains capital to issue new loans almost immediately. This cash flow from new loan originations generates profits through origination fees, points, and borrower-paid closing costs. Moreover, by offloading the loan to Freddie Mac, XYZ eliminates its default risk, transferring both the loan and servicing obligations, and this loan is then removed from XYZ’s balance sheet.
Distinguishing the Characteristics for Borrowers and Examples of Whole Loans
Whole loans are diverse and can be any loan from a single lender to a single borrower; widely known examples include mortgage loans. When your loan is sold, you will be notified and might need to set up a new payment method. However, the terms of the loan remain constant.
Why Do Lenders Choose to Sell Whole Loans?
Lenders often liquidate whole loans to generate quick cash and redirect funds into originating more loans. Although originating loans bring faster profits from associated fees, servicing them over long durations can be more labor-intensive. Consequently, selling whole loans aligns better with operational efficiency and financial liquidity.
Conclusion
While most loans start as whole loans, they are quickly sold off to major companies and bundled as securities. For borrowers, loan terms stay unchanged, but for lenders, the sale of whole loans provides immediate capital to generate further profit.
Related Terms: mortgage, secondary market, Fannie Mae, Freddie Mac, loan securitization, enterprise back securities.
References
- Fannie Mae. “Basics of Fannie Mae’s Whole Loan Conduit”, Page 3 of PDF.
