Have you ever wondered what happens to your mortgage money after you pay it off? It could end up in the secondary mortgage market. The secondary market accounts for a major portion of mortgages in the United States, allowing lenders to provide loans and allow more individuals to purchase homes. Buying a property would be more difficult without it.
Continue reading to understand the secondary mortgage market, how it works, the major participants, investors, lenders, the risks & rewards it entails.
What is the Secondary Mortgage Market?
Lenders and investors buy and sell mortgages and servicing rights in the secondary mortgage market. It was developed by the United States. The United States Congress in the 1930s. Its goal is to provide lenders with a consistent stream of funds to lend while also reducing the risk of mortgage ownership.
It is easier to maintain a steady home mortgage market with this constant circulation of money.
Who are the Major Participants of the Secondary Mortgage Market?
Mortgage originators, purchasers, mortgage investors, and homeowners are the major participants in the secondary mortgage market. Mortgage originators, or lenders, create the mortgages, which are then sold on the secondary mortgage market.
Buyers will bundle large groupings of mortgages into securities and offer them to mortgage investors, such as government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac. Investment banks, hedge funds, and pension funds are among mortgage investors.
If you own a home and have a mortgage, you may be one of the participants in the secondary mortgage market. The funds for your house purchase could have come from this market, depending on who originated your loan.
If this sounds difficult, let’s break it down and discuss how the secondary mortgage market works.
How does the Secondary Mortgage Market work?
The secondary mortgage market operates by bringing together home purchasers, lenders, and investors. This link makes homeownership more accessible to the average person. But how precisely does it work?
Assume you ask for a loan and your lender approves it. You place a bid and then close on a house, becoming the proud owner of a new home. Because of your mortgage, your lender now has less money to lend. It can recoup this money by selling your mortgage to a government-sponsored enterprise (GSE) such as Fannie Mae or Freddie Mac, or another financial institution. The lender now has more money to lend to others.
Your mortgage is then combined with other mortgages to form mortgage-backed security. The purchaser then sells these assets to investors all across the world. Pension funds, mutual funds, insurance firms, and banks are examples of these.
Shares of these bundled mortgages are purchased by investors because they provide a near-guaranteed source of consistent income. This consistent income is the result of homeowners like you paying on-time mortgage payments.
You make a payment to a mortgage servicer, which manages your loan and forwards it to the financial institution that owns the mortgage. As part of their fee for administering the mortgage, the servicer retains a percentage of the payment.
Step-By-Step Guide on How the Secondary Mortgage Market Works
Here’s a step-by-step breakdown of the secondary mortgage market.
#1. A mortgage is obtained from a lender by a home buyer.
When a property buyer secures a mortgage from a lender, the procedure begins. To close on the loan, you must complete certain standards throughout the mortgage origination phase.
#2. The loan is sold on the secondary mortgage market by the lender.
After the mortgage is originated, the lender has the option of keeping the loan on their books or selling it on the secondary mortgage market. Many institutions do not want to risk an economic downturn or lose money, therefore they will sell the loan on the secondary market to repay the money they borrowed.
#3. Government-Sponsored Enterprises (GSEs) Purchase a Large Number of Loans
GSEs will purchase several loans from various lenders. These loans could accrue interest. GSEs will now package mortgages with comparable borrower criteria into mortgage-backed securities.
#4. Mortgage-Backed Securities are purchased by investors.
The mortgage-backed securities will be sold in shares to a variety of investors by the GSEs. In many situations, investors are eager in purchasing these securities because of the promise of a long-term return.
What Are Mortgage-Backed Securities (MBS)?
Mortgage-backed securities are bonds that are backed by real estate loans and mortgages. Banks and credit unions might choose to bundle mortgages and create mortgage-backed securities when they fund mortgages. The financial institution then sells these MBS on the secondary market to private and government-sponsored businesses. The entities then utilize the MBS as collateral to establish new securities. These assets are available to investors all over the world.
The majority of those “entities” are either US government organizations, such as Ginnie Mae, or government-sponsored entities, such as Fannie Mae and Freddie Mac. The value of the underlying loans serves as collateral for the security. When a homeowner makes a monthly mortgage payment, the bondholder receives a portion of the interest and principal. The investment will be guaranteed by the institution that issued the security, and interest and principal payments will be distributed.
In general, the system works if banks enforce fair lending conditions and borrowers pay their mortgages on time.
“The majority of individuals pay their mortgages,” Haynie argues. “Except when there are truly severe economic events—and even then, the majority of people continue to pay their mortgages. As a result, from an investing standpoint, it is a rather safe type of credit.”
Who Purchases Loans on the Secondary Market?
There are three types of mortgage purchasers on the secondary market:
#1. Government-sponsored enterprises (GSEs)
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that buy conventional loans on the secondary market. If lenders intend to sell a loan to Fannie Mae or Freddie Mac, they must guarantee that both the borrower and the loan meet certain “conforming” rules established by those agencies.
#2. Government agencies:
Government-backed loans, such as FHA, VA, and USDA loans, are converted into mortgage-backed securities by Ginnie Mae, a government agency.
#3. Private entities
Pension funds, insurance companies, and hedge funds are examples of private entities. “Their underwriting criteria may differ from those of Fannie Mae and Freddie Mac,” Haynie speculates. “Some investors, for example, will specialize on loans with a greater debt-to-income ratio.”
Is the Secondary Mortgage Market Beneficial?
The advantages of the secondary mortgage market are numerous. It promotes the circulation of money, which allows borrowers to obtain cash for their home-buying demands. Rates are also kept lower and more stable by the secondary mortgage market.
Being able to sell mortgages allows lenders to fund more loans. It relieves them of the loan’s risk while yet allowing them to profit from fees.
The mortgages can then be bundled and sold as securities by the buyers. Investors who purchase these securities can expect a consistent return as a result of borrowers making their mortgage payments.
When the system is working well, everyone wins. So, retirees have money from investment funds, banks have money to lend individuals, and you can get the money you need to buy a property.
What Are the Secondary Mortgage Market Risks?
What happened in the 2008–2009 mortgage crisis was the most notable risk of the secondary mortgage market. Fannie Mae and Freddie Mac held nearly $5 trillion in mortgages on the verge of default in this situation. Other significant financial organizations, such as Lehman Brothers and Bear Stearns, have large amounts of money invested in mortgages.
Borrowers were underwater on their mortgages and were unable to make payments, resulting in foreclosures. Because of the crisis, banks either went bankrupt or swiftly sold off their mortgages and exited the market. Fannie Mae and Freddie Mac then held 100% of mortgages in the United States.
So, while the secondary mortgage market might minimize risks, if enough borrowers fail to make their payments, the whole can crumble. Following a collapse of this magnitude, only the most creditworthy customers can obtain loans. These are supported directly by large banks with enormous pockets. This reaction restricts the sorts of mortgage loans available, as well as who can obtain them.
Following the 2008 financial crisis, banks did not return to the secondary mortgage market until 2013. This brought forth a slew of adjustments. They made fewer loans and followed stricter lending guidelines.
In Conclusion
The secondary mortgage market is an interconnected network of borrowers, lenders, purchasers, and investors. It promotes the movement and availability of money while reducing the risk to lenders. It, like any other system, has advantages and disadvantages. When you strike a balance, the advantages exceed the risks.
