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

Sarah Sharkey4-minute read

May 14, 2021

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The secondary mortgage market is an expansive arena in which financial institutions and investors buy and sell mortgages. Although the average mortgage holders won’t realize what’s happening beneath the surface, their mortgage will likely play a role in the secondary mortgage market at some point.

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

The Secondary Mortgage Market, Defined

Within the secondary mortgage market, lenders and investors buy and sell mortgages and the servicing rights that go along with them. The goal of the secondary mortgage market is to provide a reliable source of money that alleviates some of the risks associated with owning a mortgage.

When mortgages are sold within the secondary mortgage market, many are packaged into Mortgage-Backed Securities (MBS). MBS are then sold to investors, including insurance companies and hedge funds.

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.

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The Major Players In The Secondary Mortgage Market

Within the secondary mortgage market, there are several major players. Here’s what you need to know.

Mortgage Originators

The mortgage originators create the 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.

Government Sponsored-Enterprises (GSE)

Government-sponsored enterprises (aka GSEs) are not mortgage originators because they cannot lend money directly to the public. However, GSEs can guarantee third-party loans and purchase loans within the secondary market.

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.

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 Fannie Mae and Freddie Mac.

Investors

Investors in the secondary mortgage market are seeking to buy mortgage-backed securities. Many investors are interested in this opportunity based on the security of the loan attached to a worthwhile interest rate.

Homeowners

As a homeowner, you may not think that the secondary mortgage market will impact you too much. An 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 the secondary mortgage market.

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.

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 chance an economic crisis or lose money; therefore, many will sell the loan to the secondary market to repay the money they took out.

Government-Sponsored Enterprises (GSEs) Buy Multiple Loans

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.

Investors Buy Mortgage-Backed Securities

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

Pros And Cons

As with all financial products, there are some pros and cons associated with the secondary mortgage market. Here’s what you need to be aware of.

Pros

Let’s start with the pros of the secondary mortgage market.

  • Low cost: The secondary mortgage market can lead to lower costs for borrowers.
  • Money movement: More liquidity opens up funds for borrowers across the country.
  • Longer terms: The secondary mortgage market makes 15-year and 30-year loan terms more feasible.
  • Refinancing a home: In most cases, a borrower can pay off their loan or refinance without a penalty.

Cons

Of course, there are also some cons to consider.

  • 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: Investors must be careful when investing in mortgage-backed securities.
  • Foreclosure risks: If borrowers are unable to pay, it can lead to foreclosures on houses and a domino effect on the economy.

The Bottom Line: Secondary Mortgage Market Fosters Money Movement

The secondary mortgage market plays a critical role in keeping the economy moving. Without it, many would-be home buyers would not be able to obtain a loan from a lender based on a lack of available funds. This could lead lending to grind to a halt, with devastating consequences.

If you are interested in learning more about the investors behind your mortgage, then take a minute to read how mortgage investors can affect your loan.

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Sarah Sharkey

Sarah Sharkey is a personal finance writer that enjoys helping readers learn more about their finances. She has an MS in Business Management from the University of Florida. You can connect with her on LinkedIn or Instagram @adventurousadulting.