What Is a Whole Loan?

Whole Loans Explained

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A whole loan refers to a single loan issued by banks or other lending institutions that is not broken up for resale in the secondary market. The lender holding it bears the risk of nonpayment. Whole loans also can be resold, which lets a lender transfer them to another financial institution to keep on its books and collect payments on.

This guide explains what whole loans are, how they work, and some of their alternatives.

Definition and Examples of Whole Loans

A whole loan is a single loan issued by a financial institution. One example is a mortgage loan secured by real estate that is made to a single borrower and serviced by the issuing lending institution. Paycheck Protection Program (PPP) Loans also are whole loans. These were issued during the 2020 pandemic to help small businesses cover payrolls.

Whole loans are an alternative to securitization, which is when a financial institution pools multiple loans and issues a security backed by these loans, known as a mortgage-backed security (MBS). These then are broken up and resold to investors.

Whole loans are not broken up; hence, the name. Lenders may resell whole loans or keep them on their books. In the latter scenario, the loans remain financial assets for the lending financial institution. It collects payment on the loans and assumes the risk of a borrower defaulting. Such loans become part of the financial institution's whole-loan portfolio.

How Whole Loans Work

Lenders service many types of loans to borrowers. These can include mortgage loans or personal loans. Lenders generally assess the borrower's credit and other factors to determine the likelihood of default.

Once a lender has issued a loan, they can continue to service the loan and collect payments on it each month. In that case, the lender takes the risk of a borrower failing to make payments. If a borrower doesn't pay back the loan, the lender will need to pursue collections activities. In the event of default, the lender would write off the loan as a loss or in the case of a mortgage, could foreclose on a house.

Lenders can also resell whole loans to investors. Investors can review the portfolio of loans offered to determine the likelihood of default when deciding how much to pay for whole loans. The buyer then would assume the responsibility of collecting payments and the risk associated with default.

Banks and other financial institutions are among the investors who may purchase whole loans. Loan-purchase activities are subject to regulatory guidelines to ensure financial institutions comply with sound risk-management principles.

Alternatives to Whole Loans

Instead of holding loans whole, banks may pool loans then issue securities backed by those loans, where the security represents a claim on the income from the loans. These securities may be broken up into different pieces, called tranches, based on the quality of the loans backing them. Mortgage-backed securities are a common example of this.

Loan servicers still manage the loans, which investors don't own directly. Instead, investors in mortgage-backed securities purchase the right to receive the payments that come from the mortgage loans.

Mortgage-backed securities have advantages for investors that whole loans do not provide. MBSs are more liquid, or simpler and quicker to sell, than whole loans. They can also attract a wider pool of investors than whole loans, which means there's more money available for lenders to issue new mortgage loans to consumers.

However, mortgage-backed securities do come with downsides. It can be difficult or impossible for individual investors to assess the quality of the loans pooled in a MBS.

In the lead-up to the 2008 financial crisis, some lenders misled investors about the quality of loans pooled into mortgage-backed securities. This was a major contributing factor to the crisis, because investors thought their securities were safer than they were.

More people are involved in MBS transactions than those a lender keeps on their books. This can increase costs and result in potential conflicts of interest. For example, lenders may have the incentive to approve as many loans as possible so those loans can be resold and securitized. Investors, however, are better off if mortgage lenders are more careful regarding to whom they provide loans.

Key Takeaways

  • Whole loans are single loans made by financial institutions, including mortgages and personal loans.
  • Lenders can keep whole loans in their portfolios and collect on them.
  • Whole loans can be resold to investors.
  • The lender or investor who owns the whole loan bears the risk of borrower default.
  • Mortgage-backed securities (MBSs) originate from whole loans and are an alternative to them.