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

4-Minute Read
Published on November 11, 2020

Ever wonder what happens to your mortgage money after you’ve paid it? It’s possible that it ends up in the secondary mortgage market. A large percentage of mortgages in the U.S. are a part of this market, which helps lenders make loans so more people can fund their homes. Without it, buying a home would be more difficult.

Read on to learn what the secondary mortgage market is, how it works and its risks and benefits.

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What Is The Secondary Mortgage Market?

The secondary mortgage market is where lenders and investors buy and sell mortgages and their servicing rights. It was created by the U.S. Congress in the 1930s. Its purpose is to give lenders a steady source of money to lend, while also alleviating the risk of owning the mortgage.

With this regular movement of money, it’s easier to maintain a stable residential mortgage market.

It’s important to note the main difference between the primary market versus the secondary market for mortgages. In the primary mortgage market, the borrower interacts directly with their lender to receive financing for their home. After the borrower closes on their new home, the lender may sell the loan to a third-party investor, which represents the secondary market. But who are those investors?

Who Are The Major Participants In The Secondary Mortgage Market?

The key participants in the secondary mortgage market are mortgage originators, buyers, mortgage investors and homeowners. Mortgage originators, or lenders, create the mortgages, then can sell the servicing rights on the secondary mortgage market.

Buyers, like government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac, will bundle large groups of mortgages into securities and sell them to mortgage investors. These mortgage investors include investment banks, hedge funds and pension funds.

If you’re a homeowner with a mortgage, you could also be a participant in the secondary mortgage market. Depending on who originated your loan, the money to fund your home purchase could’ve come from this market.

If this seems complicated, let’s tease it out and talk about how the secondary mortgage market works.

How Does The Secondary Mortgage Market Work?

The secondary mortgage market works by connecting home buyers, lenders and investors. This connection makes homeownership more possible for the average person. But how does it work, exactly?

Say you apply for a mortgage and your lender approves. You make a bid and close on a home, becoming a proud owner of a new house. Your lender now has less money to lend out because of your mortgage. It can recoup this money by selling your mortgage to a GSE, like Fannie Mae or Freddie Mac, or other financial institutions. Now the lender has more money to loan out to others.

Your mortgage is then pooled together with other mortgages and creates a mortgage-backed security. The buyer then sells these securities to investors from around the world. These can be pension funds, mutual funds, insurance companies and banks.

Investors buy shares of these bundled mortgages because they’re a near-guaranteed source of steady income. This steady income comes from homeowners like yourself making regular mortgage payments.

You pay a mortgage servicer – the company that manages your loan – and they send the payment to the financial institution that owns the mortgage. The servicer keeps a percentage of the payment as part of their fee for managing the mortgage.

Benefits Of The Secondary Mortgage Market

What does the secondary mortgage market do for the housing market? The benefits are plentiful. The system encourages the movement of money, which helps borrowers gain access to funding their home buying needs. The secondary mortgage market also keeps mortgage interest rates lower and more consistent.

For lenders, being able to sell mortgages means they can fund more loans. It relieves them of the risk of the loan, and they can still make money on fees.

The buyers can then bundle the mortgages and create securities. Investors who buy these securities can receive a reliable return due to borrowers paying their mortgage payment.

When the system works, there are wins across the board. Retirees have money coming from investment funds, banks have money to loan people and you have access to the money you need to buy a home.

Risks Of The Secondary Mortgage Market

The most notable risk of the secondary mortgage market is what occurred in the 2008 – 2009 mortgage crisis. In this situation, Fannie Mae and Freddie Mac held nearly $5 trillion in mortgages on the edge of defaulting. Other large financial institutions, like Lehman Brothers and Bear Stearns, also had large amounts tied up in mortgages.

Borrowers were in too deep on their mortgages and were not making payments, leading to foreclosures. This crisis caused banks to either capsize or to quickly sell off their mortgages and leave the market altogether. Fannie Mae and Freddie Mac then held 100% of mortgages in the U.S.

So, while the secondary mortgage market can reduce risks, if enough borrowers can’t make their payments, it can cause the system to fall apart. Following a collapse like this, only the most credit-worthy customers can get home loans. These are directly funded by big banks with deep pockets. This reaction limits the types of mortgage loans issued, along with who they’re issued to.

Following the crisis in 2008, it wasn’t until 2013 that banks started to return to the secondary mortgage market. This came with many changes. They made fewer loans and adhered to stricter lending requirements.

The Bottom Line: The Secondary Market For Mortgages Makes Homeownership Possible

The secondary mortgage market is a system of borrowers, lenders, buyers and investors. It encourages the liquidity and availability of money, while minimizing risk for lenders. Like any system, it comes with pros and cons. When balance is achieved, the benefits outweigh the risks.

If you’re a hopeful home buyer, you may soon be an active participant in the secondary mortgage market. Make sure to apply for a mortgage and speak with an expert who can help you understand the ins and outs of your home loan.

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Victoria Araj

Victoria Araj is a Section Editor for Rocket Mortgage and held roles in mortgage banking, public relations and more in her 15+ years with the company. She holds a bachelor’s degree in journalism with an emphasis in political science from Michigan State University, and a master’s degree in public administration from the University of Michigan.