When you borrow money to buy a home, your loan is almost always “securitized.” Pope Francis recently railed against complex financial securities. Although he did not condemn all securitization, he echoed the feelings of many less divinely inspired people who also question the practice. In fact, borrowers really need securitization.

In this article I’ll outline the process and explain how it helps borrowers.

Pope Francis (Photo by ALBERTO PIZZOLI/AFP/Getty Images)

The process begins with a loan from a bank or mortgage company. After the loan is closed, the bank combines your loan with hundreds of other similar loans. The bank usually continues to receive the payments, but it forwards them—less a servicing fee—to whoever bought the package of loans.

The bundle of loans is then sliced up based on the timing of the payments. For example, payments that will come in the first year would be one slice; payments to be received in the second year would be another, and so forth through the life of the loan. It’s actually more complicated, with rules about how to handle defaults, extra payments and prepayment of an entire loan. More details are available in my article “What Is Securitization: A Very Basic Example.”

This seems overly complicated, but it really helps to find investors who will put up the cash for the loans. Consider the alternative, that the bank makes the loan from the funds provided by depositors. Suppose that a bank is making a loan at four percent interest. The bank uses deposits for which it pays one percent. (This is just an example.) The bank has a three-percent spread to cover the cost of making the loan and  taking in deposits, overhead and profit. With efficient operations and good volume, it’s a profitable business.

Profits go away, though, if interest rates rise. The mortgages are fixed at four percent, even if inflation has caused new mortgage rates to be or eight percent. But to keep the depositors satisfied, interest rates on savings accounts or certificates of deposit have to rise, let’s say to five percent.The bank is now losing money. It cannot demand that the mortgage borrowers pay a higher interest rate—those rates are fixed. And if it does not pay higher rates on deposits, then customers will ask for their money back and take their business elsewhere. The bank cannot pay off those depositors, though, because the deposits were used to make mortgage loans that won’t be paid back for years.

This is what destroyed the old savings and loan industry in the 1980s. Because of the interest rate risk, today few banks will make a long-term loan funded with short-term deposits. But securitization offers another path.

Few investors want to purchase the income stream from a mortgage. Most investors have a preferred time horizon. Short-term investors don’t like having some of their money tied up for 30 years. Long-term investors don’t like getting cash in the first few years—they want to keep their money working. Intermediate-term investors are unhappy with both early cash payments and later cash payments. To induce any of these investors to buy the entire mortgage would require pretty high interest rates.

Slicing up the mortgages by timing of the payments solves this problem. One investor, such as a money market mutual fund, will purchase the right to receive the first year’s payments. That fits exactly the fund’s time horizon. Another investor, such as a fire insurance company, will purchase the right to receive the second year’s payment. Again, this is a perfect fit with the company’s needs. At the long end, a university endowment or a pension fund might purchase the right to the thirtieth year’s payments. None of these investors is borrowing at short-term interest rates in order to invest in long-term assets, so danger is avoided.

Without securitization, mortgage lending is very risky. If depositors would promise to leave their money in the bank for 30 years at a fixed rate, there would be no problem. But most of us want the flexibility to withdraw our funds. If borrowers would be happy with floating rate loans, then banks could maintain their margin between deposit interest rates and mortgage loan rates. But most borrowers don’t want the risk of their interest cost going through the roof.

Securitization is a tool, and like any tool it can be used in a risky way. Some investors may borrow short-term money to buy those long-term slices of the mortgage pool. That’s risky, but it’s not a problem for the whole economy—just for those investors.

Given the potential for swings in interest rates, securitization is actually safer than traditional banking for mortgage loans. And with greater safety for investors, interest rates are lower and credit availability is greater. Securitization helps borrowers.