Why Banks Sell Loans and How It Impacts You

I just got a letter in the mail from my student loan company saying that my loan has been sold to the US government and will now be processed by a federal payment processing center.  This is common in the student loan and mortgage loan business.  I figure that if it is happening to me, it is happening to other people to.  And if a bank does it, it is probably confusing.  Here is how it works.

If you have a student loan like I do, you make a regularly scheduled payment to the issuing bank.  When dispersed, the loan company paid my school on my behalf.  The money is already out the door, and my payments are reimbursing the bank for the payment plus interest.

The money the bank lent out was from other customer’s savings accounts and certificates of deposit.  If the accounts are not touched for a long time, that is great for the bank.  They pay 1% interest to the customer and loan the funds out at 7% (example).  That is a 6% earnings while the money is there.  However, if a lot of customers want their savings back, the bank has to give it to them.  If the money is all loaned out, they need to either borrow from other banks or sell assets.

The primary asset of banks are loans.  It is an asset because it is money that they are expecting in the future.  They can sell a group of loans together to another bank, or the government, for a slight discount.  If they have $10,000,000 in loans outstanding, the other bank might pay $9,500,000 for title to the loans.  That will ensure the bank is protected from potential losses on future loans.

That all sounds complicated, but for you it is not.  Here is how simple it is for you: you just make your payments to someone else.  That’s it.

Any questions?  Anything I missed?  Let me know in the comments.

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