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 the risks and benefits associated with it.
Secondary Mortgage Market, Defined
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.
Who Participates 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 bundles large groups of mortgages into securities and sell them to mortgage investors. These mortgage investors include investment banks, hedge fund 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 have 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 home. 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 is due to 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.
Are There Benefits To The Secondary Mortgage Market?
The benefits to the secondary mortgage market are plentiful. It encourages the movement of money, which helps borrowers gain access to funding their home buying needs. The secondary mortgage market also keeps 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 then can 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.
What Are The 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 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 mortgage market is a system of borrowers, lenders, buyers and investors. It encourages the movement and availability of money, while minimizing risk to lenders. Like any system, it comes with benefits and risks. When balance is achieved, the benefits outweigh the risks.
Are you interested in applying for a home loan? Talk to a Home Loan Expert at Quicken Loans® for answers to your mortgage questions.