A Guide To The Mortgage Market

9 Min Read
Published Dec. 29, 2023
Neighborhood block with nice houses.
Written By Ashley Kilroy

The mortgage market, a cornerstone of the housing economy, serves as the financial engine that propels countless borrowers toward the dream of homeownership. Behind the scenes, the dynamic interplay of primary and secondary markets, interest rates influenced by the Federal Reserve and a myriad of personal factors shape your loan amount, interest rate and other terms. Understanding the system’s underlying structure is essential to securing the loan that suits your needs with the best terms and rates.

What Is The Mortgage Market?

The mortgage market is the industry providing loans for purchasing homes. Because most home buyers need capital to help buy a home, mortgages are essential to the housing economy. Borrowers work with lenders to secure financing, which they apply to the home purchase.

The mortgage market consists of two parts: a primary and a secondary market. The primary market consists of lenders that originate mortgages for consumers. The secondary market consists of mortgage investors like Fannie Mae and Freddie Mac. These institutions buy mortgages to provide liquidity for lenders to make additional loans.

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What Is The Primary Mortgage Market?

The primary mortgage market is where potential home buyers engage with mortgage originators (individuals and institutions that approve, underwrite and provide mortgage loans). Borrowers approach mortgage originators for financing for a home purchase. 

How Does The Primary Mortgage Market Work?

The process of obtaining financing starts with an application, where you provide information about your financial situation, employment history, credit history and the kind of property you intend to purchase. Then, the lender evaluates the application through the underwriting process to determine if the borrower qualifies for the loan. If the borrower passes underwriting, the lender issues its approval. Lastly, the borrower can close on a home if the house appraises for a price within the approved loan amount.

Several types of financial institutions provide mortgages to borrowers in the primary market. You can obtain a mortgage by working with the following entities:

  • Mortgage brokers: Liaisons that connect borrowers to banks, credit unions and other lenders.
  • Mortgage bankers: A company or person who provides mortgages to borrowers.
  • Commercial banks: Companies that offer savings and checking accounts, mortgages and other loans.
  • Credit unions: Nonprofits that provide the same services as commercial banks.
  • Savings & loan associations: Locally based financial institutions that specialize in mortgage loans.

What Is The Secondary Mortgage Market?

The secondary mortgage market is where mortgage originators from the primary market sell the loans they make to institutional investors. This way, the primary market lenders recover the loan amount to make future mortgage loans.

Secondary mortgage market investors package the mortgages they purchase into mortgage-backed securities (MBS). Third-party investors, including hedge funds, investment banks and pension funds buy MBSs to generate returns from the interest rate.

Primary Vs. Secondary Mortgage Market

The secondary mortgage market buys mortgage loans from primary market lenders. This function provides a consistent stream of funding back to the primary market, allowing mortgage originators to make more loans without waiting between 15 – 30 years for borrowers to repay their mortgages.

The secondary mortgage market investors are government-sponsored enterprises (GSEs) and private financial companies that support the primary market. The GSEs in the market are Fannie Mae and Freddie Mac, which buy mortgage loans from various sectors of the primary mortgage market. The secondary market investors then bundle the mortgages they purchase to sell to outside investors.

GSEs also enforce lending limits for the primary market created by the Federal Housing Finance Agency (FHFA). Mortgage originators follow these standards for maximum loan size to manage the risk of providing home loans. Remember, GSEs won’t buy loans that surpass the limit, discouraging lenders on the primary market from making them.

Advantages Of The Primary Mortgage Market

The primary mortgage market is a crucial intermediary for borrowers and investors alike. Here are the benefits they offer:

  • Flexibility: Mortgage lenders match borrowers with specific types of loans based on their financial circumstances. For example, a conventional mortgage usually requires a credit score of 620, while an FHA loan lowers the standard to 580.  
  • Low down payments: Down payment requirements fluctuate depending on the loan type, the borrower’s credit score, and more. While a 20% down payment helps you avoid mortgage insurance and establish equity upon buying the home, it’s not necessary to qualify for a loan. For example, conventional mortgages require as little as 3% down while VA loans don’t require a down payment at all.  
  • Closing costs: Originating a mortgage involves fees for underwriting, appraisals, application processing and more. Generally, borrowers pay these costs when closing on the home loan, but lenders sometimes allow borrowers to roll closing costs into the home loan. Doing so lowers the financial barrier to homeownership but increases your loan amount.
  • Affordable interest rates: Mortgages have some of the lowest interest rates among all forms of debt. Mortgage originators achieve these rates by securing the loans with the homes borrowers purchase and selling loans to the secondary market instead of relying on interest payments for profits.
  • Investment opportunities: As described above, the primary mortgage market supplies the secondary market with loans, allowing private investors to add mortgage-backed securities to their portfolios. Interest earnings from these investments fuel the growth of retirement funds, brokerage accounts, and more.

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Understanding Mortgage Interest Rates

Mortgage interest rates fluctuate along with the rest of the economy. In addition, the borrower’s financial profile affects the rate they receive. As a result, mortgage interest rates can seem arbitrarily high or low depending on when you apply for a loan. However, the truth is the opposite – various factors come together when a lender gives you an interest rate to match your financial circumstances and the overall housing market. Here are the details and the ways to get the best interest rate in the given circumstances.

Mortgage Market Interest Rates

Lenders determine interest rates through a variety of factors, including a borrower’s credit score and debt-to-income ratio (DTI). However, the baseline for mortgage interest rates comes from the Federal Reserve (Fed), which sets interest rates for the American economy. Specifically, the federal funds rate affects how much interest banks charge when lending to each other and the rates investors expect when purchasing MBSs. Lenders on the primary mortgage market use federal reserve rates to gauge how high interest rates must be to attract investors from the secondary market while maintaining affordability for borrowers.

The Fed constantly balances two competing priorities: achieving maximum employment and maintaining stable prices. Interest rates need to be low enough to make hiring workers and investing in business worthwhile but high enough to inhibit inflation. As a result, the Fed adjusts the interest rate as it sees fit, which causes ripple effects in the mortgage market’s interest rates.

For example, back in the beginning of 2021, the effective federal funds rate was 0.0% – 0.25%. This rate kept interest rates across the economy low. Since then, global conflicts and inflationary concerns caused the Fed to raise the effective federal funds rate, which currently sits at 5.25% – 5.50%. This increase has caused mortgage interest rates to increase substantially in the last 2 years.

Mortgage Interest Rates And The Current Market

Current mortgage market trends involve higher interest rates than in years previous. The Fed has hiked rates to combat inflation, keeping prices from running away. While doing so has led to higher mortgage interest rates, mortgage loans remain some of the lowest-interest debt available in the American economy. As a result, homeownership is still attainable, and the market has weathered worse storms in the past. For instance, mortgage rates peaked at about 10% in 1981. Rates dropped for the next two decades while property values soared, more than making up for the interest costs involved in a mortgage.

Home Buyer’s Interest Rates 

Numerous financial factors can influence your mortgage interest rate. Lenders use these factors to assess the risk associated with lending money and determine the appropriate interest rate for the borrower. Here’s a comprehensive list of factors that can impact your interest rate:

  • Credit score: Lenders assess the risk of lending through a borrower’s credit profile. A higher credit score generally results in a lower interest rate.
  • Down payment amount: A larger down payment means borrowing less from your lender. Because smaller loan amounts are less risky, you can get a lower interest rate by putting down more on closing day.
  • Debt-to-income ratio (DTI): A lower DTI (the ratio of your monthly debt payments to your gross income) is favorable for securing a lower interest rate. Lenders assess DTI to evaluate your ability to manage additional debt. Specifically, conventional loans have a DTI limit up to 50% .
  • Mortgage points: Borrowers can buy mortgage discount points upfront to lower their interest rate over the life of the loan. Each point typically costs 1% of the loan amount and can reduce the interest rate by about 0.25%.
  • Loan-to-Value Ratio (LTV): LTV compares the loan amount to the appraised value of the property. You can achieve a lower LTV by negotiating a lower price with the seller or making a larger down payment. This way, your loan amount is less than the home is worth, reducing the lender’s risk.
  • Loan term: Shorter loan terms (15 years) may have lower interest rates than longer terms (30 years) because lenders consider shorter terms less risky. The longer you hold the loan, the more time you have to default.

When you’re ready to buy a home, it’s advisable to get preapproved for a mortgage before looking at available houses. You’ll lock in your interest rate and demonstrate your reliability to sellers when making an offer. You’ll also have a better idea of how much house you can afford.

In addition, assistance programs are available if the down payment and the closing costs are daunting. First-time home buyers often have the easiest time qualifying for these programs, which you can find with government agencies and private nonprofits in your area. Taking advantage of these programs instead of rolling more costs into your loan amount will decrease your interest expenses over the life of the loan. Just keep in mind that not all lenders accept every program. It’s best to speak to your lender to see which ones they accept.

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The Bottom Line

The mortgage market plays a pivotal role in the housing economy, enabling individuals to achieve homeownership through the provision of essential loans. The primary and secondary mortgage markets reveal a dynamic system where borrowers, lenders and investors collaborate to facilitate property transactions.

Remember, as a borrower, your main concern will be your relationship with the primary mortgage market. Finding a lender that fits your preferences and needs is vital to your home buying journey. Informed decision-making empowers borrowers to secure the best terms for their home loans. Don’t wait – today.