Wholesale lenders, thrifts, etc. create (sell) the loans. Then FNMA, Freddie Mac or other "poolers" create the security and the insurance certificate that allows the final investor to have "faith" in the security in the first place. They have underwriting standards that must be adhered to for the loan to "get insured and pooled" in the first place.

Are these "insurers and poolers" what you are calling the "investment company"? If so, they make money by getting an insurance premium.

When you say "investment company" you mean, the selling of the MBS to the final investors...well a commission is charged just like selling any investment product.

The final buyers of the MBS are usually big companies ...insurance companies, mutual funds, FNMA & Freddie themselves, REITs, foreign central banks, etc. and they are looking for a return on investment that beats the 10 year bond...which MBS consistently do by about 1%.

This secondary marketing system replaced local banks as the sole source of real estate capital and added liquidity to the system.

In the old days, if your local bank ran out of money...no more real estate loans. The secondary market insures there is always a supply of money of real estate loans.

The insurance (or more accurately ...assurance) that FNMA or Freddie adds as "quasi-governmental institutions" to final investors giving them the feeling of safety and security was the key to developing a secondary market for mortgages. Since the final investors feel investing billions in MBS is virtually as safe as investing 10 year US bonds...why not earn an extra 1% with the MBS for the same risk, right?

Hope this answers the question...

This was a rundown for the "A" paper secondary market...it's a little more complicated for the 'B" paper or subprime secondary market.

Thanks. That's kind of what I was looking for.

By "companies", I was more specifically referring to investment banks that pool the loans and then sell them out as securities to final investors (securitization).

I think I get it though. The interest paid from the original borrowers is passed through the investment bank and then used to pay the final investors. Meanwhile, the investment bank buys the loans from a thrift for a certain price and issues them out to investors at a higher price (the spread). This is how the investment banks make money on MBS. Is this right? Or am I missing something?

You've got the basic gist...there's an extra step, but yes, every one...retail producer, wholesale lender, pooler/insurer, final investor...all "markup" to get their return...plus charge fees at times to make their money.

The final investor says today, "I need a ROI on a 30 year fixed pool of 6%, so FNMA(insurer/pooler) says, "Let me add my cut of .125%", the wholesale lender says, "Let me add my cut of .25%", and the retail mortgage broker says, "Let me add my cut of .5%"...and the customer ends up with a rate of 6 +.125 + .25 + .5 = 6.875%...which by the way is what HSH.com says last week was the average rate for a 30 year fixed.

BTW the bounce in the rate at the retail level...the .5% in our example is causing a real controversy in the industry. It's called Yield Spread Premium..and since most banks and brokers get a fee for originating (usually 1%) the loan, why are they also getting a "cut" by bouncing the rate?

Seems like "double-dipping" if you ask me. And that rate bounce, creates a ton of cash at closing for the bank or broker doing it (and they all do it)...usually 2% of the loan amount. It's usually not disclosed that the bank or broker is make a whopping 3% on every loan...1% origination fee plus 2% in YSP.

Learn as much as you can about Yield Spread Premium overcharging before you do your next mortgage.

Thanks a lot. I'll have to continue doing some more research into this.

Regarding the YSP, are you referring to companies such as Wells Fargo for instance, as a retailer? And for "double dipping", do you mean they are getting interest on both the original loan and on the issuance of these loans to the issuer/pooler?

Actually I'm not necessarily interested in investing in MBS. Rather, I'm currently a finance student, and am reading a book called "Liar's Poker" where they mention MBS. Hence, I did some reading and was a little confused.

Do you have any links or books you recommend I check out for further information? I've heard good stuff about Fabozzi's books on fixed income and MBS.

Sorry for all the questions. You've been most helpful though.

"Retailer" means anyone the home owner applies for a mortgage with...so yes, Wells Fargo, Countrywide or your local mortgage broker all fit the definition of "retailer". Therefore they all make money with YSP...rate bumping and from fees too. I'd call that "double-dipping", but everyone does it.

Here's a few books you could look into:

Real Estate Finance ; John P. Wiedemer; Published by Prentice Hall College Div (Hardcover); February 1995; $50.05
Collateralized Mortgage Obligations: Analysis, Valuation and Portfolio Strategy; Thomas S.Y. Ho, Yung C. Lim, Andrew S. Davidson; Published by Probus Pub Co (Hardcover); September, 1994; $52.50

Good Luck