What Is The Secondary Mortgage Market And How Does It Work?

The secondary mortgage market is an expansive real estate arena in which financial institutions and investors buy and sell mortgages. Although the average mortgage holder won’t realize what’s happening beneath the surface, their mortgage will likely end up on the secondary mortgage market at some point.

Here’s what you need to know about the secondary mortgage market.

The Secondary Mortgage Market Explained

The secondary mortgage market is how lenders and investors buy and sell mortgages and the servicing rights that go along with them. When mortgages are sold within the secondary mortgage market, many are packaged into mortgage-backed securities (MBSs). MBSs are then sold to investors, including insurance companies and hedge funds.

Why Do Lenders Sell Mortgages?

When a lender offers you a mortgage, they carry the debt on their balance sheet until you’ve paid them back in full. Since most mortgages take about 10 – 30 years to pay off, lenders may need to carry the debt for a long time.

By selling mortgages to investors, lenders can take the debt off their books. This can free up money that lenders can then use to offer more mortgages to home buyers.

Why Do Investors Buy Mortgages?

MBSs are valued by investors because they provide a stable rate of return based on the mortgage terms that you’ve negotiated with your lender. They know that most homeowners will want to pay their mortgages and if a homeowner defaults, the home acts as collateral to protect the investment.

This makes it less volatile than stocks while offering a higher potential rate of return compared to treasury notes and other government bonds.

Does The Secondary Mortgage Market Put Your Mortgage At Risk?

The secondary mortgage market actually protects home buyers and helps keep the housing market stable. It does this by setting lending limits, and minimum credit score and debt-to-income (DTI) ratio standards that lenders must observe if they want to be able to sell their mortgages on the secondary market.

This provides lenders with an incentive to only offer mortgages to qualified home buyers.

All in all, the secondary mortgage market creates a type of liquid investment that aids in making loans available to the borrower. With that, the secondary mortgage market is critical to creating regular access to borrowing power.

Primary Vs. Secondary Mortgage Market

As a consumer, you’re likely already familiar with the primary mortgage market, where borrowers can secure a mortgage loan from a lender.

For example, if you are shopping for a home and choose to close on a home with the help of Rocket Mortgage^®, then you would be a participant in the primary mortgage market.

The secondary mortgage market comes into play after the borrower has closed on their mortgage. At that point, the lender may choose to sell the mortgage or the associated servicing right in the secondary mortgage market.

Who Are The Major Participants In The Secondary Mortgage Market?

Within the secondary mortgage market, there are several major players. Here are some of the major participants to know.

Mortgage Originators

The mortgage originators create the home loans. Without the mortgage originators, the secondary mortgage market could not exist.

Once the loans are originated, the mortgage originators can choose to sell it or the servicing rights in the secondary market.

Mortgage Aggregators

Government-sponsored enterprises (also called GSEs) and other buyers act as mortgage aggregators by buying mortgages from lenders.

Once the GSEs buy the mortgages, they can group the collection of mortgages into securities and sell them to investors. Two major names in this space are the Federal National Mortgage Association (also called Fannie Mae) and the Federal Home Loan Mortgage Corporation (nicknamed Freddie Mac).

The purpose of GSEs buying mortgage loans in the secondary marketplace is to ensure liquidity for mortgage originators. This liquidity allows for lenders to continue providing borrowers with access to the loans they are seeking.

GSEs don't lend money directly to the public. However, GSEs do guarantee third-party loans and purchase loans within the secondary market.

Sometimes mortgages are purchased directly by the government itself. This is the case with Federal Housing Administration (FHA) and Department of Veterans Affairs (VA) loans.

Investors

Real estate investors in the secondary mortgage market are seeking to buy mortgage-backed securities based on the security of the loan with a worthwhile interest rate.

Homeowners

As a homeowner, you may not think that the secondary mortgage market will impact you too much. And in general, you are correct. But without homeowners, the secondary mortgage market could not exist.

How The Secondary Mortgage Market Works: Step-By-Step

Here’s a step-by-step look at how the secondary mortgage market works and how lenders, home buyers and investors are connected.

Step 1: Home Buyer Obtains A Mortgage From A Lender

The first step of the process is when a home buyer obtains a mortgage from a lender. In this mortgage origination phase, you’ll have to meet specific requirements to close on the loan.

Step 2: Lender Sells The Loan On The Secondary Mortgage Market

After the mortgage has been originated, the lender can choose to hold the loan on their books or sell it on the secondary mortgage market. Many institutions do not want to risk an economic crisis or lose money, so many will sell the loan to the secondary market in order to repay the money they took out.

Step 3: Loans Are Bundled Into Mortgage-Backed Securities

GSEs will buy multiple loans from many lenders. These loans may accumulate interest. At this point, GSEs will package up mortgages with similar borrower criteria into mortgage-backed securities.

The same process takes place with loans backed by the government, but those loans are packaged through the Government National Mortgage Association, also referred to as Ginnie Mae.

Step 4: Investors Buy Mortgage-Backed Securities

GSEs will sell MBSs to multiple investors through shares. In many cases, investors are interested in buying these offerings for the promise of a return over time.

Step 5: Mortgage Loans Are Managed By A Loan Servicer

After the loan has been sold on the secondary mortgage market, it will be transferred to a loan servicing company. This company is paid a service fee to collect your monthly mortgage payment, manage your escrow account and provide customer support as required.

Pros And Cons Of The Secondary Market In Mortgage Lending

While the secondary mortgage market may not be front of mind for mortgage lenders and borrowers, it does have certain pros and cons which can affect home buyers and homeowners.

Pros

Some of the pros of the secondary mortgage market include the following:

• Clear standards are established: By setting clear standards for credit scores and DTIs that lenders are encouraged to observe, borrowers can know how their credit history may affect their ability to get a mortgage or refinance a loan.
• Lower borrowing costs: By keeping lenders liquid, the secondary mortgage market creates a greater supply of money to lend and greater competition. This leads to lower costs for borrowers.
• Longer loan terms available: Because lenders know they won’t have to carry the mortgage debt on their books, it makes 15-year and 30-year loan terms more feasible.

Cons

Of course, there are also some cons to consider.

• May not qualify with low credit score: Borrowers with low credit scores may not be able to obtain a loan based on the requirements set by the secondary mortgage market.
• Can be a risk: While mortgage-backed securities are considered lower risk, there is potential risk that can affect the housing market at large. This can cause a drop in home prices which may lower a homeowner’s available equity.
• Higher costs for jumbo loans: If borrowers need loans that don’t conform to existing limits, they may need to pay a higher interest rate or make a larger down payment to their lender to qualify.

The Bottom Line

The secondary mortgage market plays a critical role in keeping the economy moving. Without it, many potential home buyers would not be able to obtain a loan from a lender based on a lack of available funds. This could cause lending to come to a standstill, with severe repercussions.

If you feel ready to get a mortgage and become a part of the secondary mortgage market, you can start an application online today.