Recent events in the money markets have shown that once you sign that mortgage / loan deal, do you really know what happens, and where your liability may end up? Unless you have done some major research into the sector, you will probably not be aware about what goes on behind the scenes.  Let us tell you what happens…….

Once you sign that mortgage or loan deal, there is every chance that your agreement could be split up into many pieces and sold to a number of financial companies around the world.  But how is this done?

Simple!

When you sign a financial agreement you will create two separate income streams, interest and capital, which will be stripped and bundled up with a variety of other financial elements.  By bundling many different qualities of income stream into a new financial instrument, it is possible to create a customised vehicle for any requirement.  Risks and the duration of the instrument can be varied simply by taking on different “strips” of any other agreement.

So in effect you take your mortgage out in the UK and within a matter of days your agreement could be scattered to all areas of the world.  This is part of the problem with the ongoing credit crunch in that nobody really knows who is at risk until the pack of cards start to fall, then A cannot pay B who cannot then pay C, and so on.  After a short period of time, liquidity dries up, finical institutions need to retain their funds, and the internal money market is dead.  Step forward Northern Rock for 75% of that last mortgage they agreed, in the form of a commercial loan, but the funding is not there!

While the above description may sound a little simplistic , it really is that simple.  A lack of confidence in the money markets can lead to banks withdrawing their finance from the markets, which results in other companies not being able to function normally, which results in Northern Rock like situations.

Northern rock is a little different than most banks as it borrows a large amount of mortgage funding from the market, rather than being in a position to use its own assets.  The likes of Barclays, Lloyds, etc are total different in that they are more likely to use their own asset to back 75% of a mortgage agreement, and borrow 25% from the money markets.