What Is a Conduit Loan?

Conduit loans were first developed as a way to assist banks in selling their loan contracts on the bond market. Prior to banks' initiating this type of sale, money that was lent out would earn only interest from the borrower. It was tied-up in the loan until the borrower repaid the debt. By reselling the loan on the bond market, banks could entice investors to give them more capital, allowing for additional lending.

One problem that came out of this arrangement was the common prepayment of mortgages. With the help of government organizations like Fanny Mae and Freddy Mac, banks began designing loans that were specifically made to be resold as bonds by prohibiting prepayment. If the loan was prepaid, the borrower would have to buy enough government bonds to replace the lost income to investors. To entice borrowers into this arrangement, banks offered conduit loans at low interest rates.

After the mortgage collapse of 2007, fewer investors continued purchasing conduit loans and mortgage-backed securities. As a result, the banks could not offer low interest rates as they had in the past. Fewer borrowers take out conduit loans since the draw of a lower interest rate is not as strong as it once was.


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