What is a conduit loan
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History of Conduit Loans
The Residential Funding Corporation, or RFC, is believed to be the first organization to develop conduit loans. The concept was to purchase loans above the allotted limits set by Fannie Mae and Freddie Mac. These loans, called jumbo loans, could not be purchased by the federally endorsed institutions. RFC used a network of brokers, thrifts and banks to issue loans. It then purchased those loans and sold them as securities for a profit.
A conduit loan starts out with a similar structure to any other mortgage. In fact, General Motors Acceptance Corporation, or GMAC, one of the nation's leading lenders, used the conduit loan model beginning in 1990. The company issued debts to consumers, and, once enough loans had been issued, was able to package these loans in order to sell stock in its own company. The model provides profit as long as there is a steady stream of loans coming in.
The FDIC recognizes two general types of conduit lenders. The first type simply purchases loans in order to securitize them. This is the basis
of conduit lending, and it is where the practice initially started. The second type of conduit lender also services the loans. GMAC is an example of a lender that engages in servicing as well as securitizing of conduit loans.
The risks of this type of securitization were exposed in the financial collapse of 2007. When lenders lowered their standards, offering loans to borrowers who likely would not be able to repay, the loans were of little value on the securities market. These loans, including subprime loans, turned the mortgage-backed securities market on its head. When they were repackaged and sold, these conduit loans carried with them a large amount of risk of the original borrower defaulted.
Conduit Loan Criticisms
After the mortgage meltdown exposed the systematic risk of conduit loans, many criticized not only the lenders who issued bad debts, but the third parties that packaged and sold those debts to the general market. Since then, the practice of purchasing mortgage-backed securities has become not just risky but often snubbed by investors who feel they were exposed to undue risk from conduit lenders in the past.Source: ehow.com