Investment funds are buying up billions of dollars worth of loans discounted from the original value and are reducing homeowners mortgage balances to enable borrowers to refinance into FHA loans.

This allows the firms to generate pocket sizable profits by reselling new government-insured and then bundling the mortgages into securities for sale to investors says the New York Times. 

As an example, the Times writes that

a fund might offer to pay $40 million for a $100 million block of mortgages from a bank in distress. Then the fund could arrange to have some of those loans refinanced into mortgages backed by an agency like the F.H.A. and then sold to an agency like Ginnie Mae. The trick is to persuade the homeowners to refinance those mortgages, by offering to reduce the amounts the homeowners owe.

The profit comes when the refinancings reach more than the $40 million that the fund paid for the block of loans.

They provide a great graphic here which helps explain how it works. 

This type of thing isn’t only happening in the “forward” business either.  When the the FDIC approved a letter of intent to purchase IndyMac earlier this year, a portfolio of $1 Billion of proprietary reverse mortgage loans started being shopped around but the consortium couldn’t find a buyer.

About a month before the IndyMac deal closed, HUD announced it was raising the national loan limit for HECMs to $625,000.

Sources close to the investors purchasing IndyMac told RMD that the purchase of Financial Freedom was going to be very profitable because of the new loan limits and the discount the buyers were receiving on the portfolio of proprietary reverse mortgages (Cash Accounts).

Starting in June, Financial Freedom’s retail division began contacting Cash Account borrowers offering to refinance those loans into HECMs by reducing the outstanding balance.  The discounted purchase price of the loans allowed them to do this on a substantial amount of the portfolio. 

All in all, it turned out to be a great deal for many borrowers as well as the One West since the company was able to refinance the loans off their balance sheet and sell the production generating a significant amount of revenue for the company. 

Wall St. Finds Profits by Reducing Mortgages