If you’ve got a long-term mortgage with cheap loan terms, the secondary mortgage market is partly to thank for that sweet deal.
“If the secondary market didn’t exist, it would be difficult for you to get a 30-year fixed-rate mortgage,” says Ron Haynie, senior vice president of mortgage finance policy for the Independent Community Bankers of America. “And if you could get one, it would be at a much higher rate than it is today.”
If you lived through the financial crisis of 2008 or saw the movie The Big Short, then you may already know a bit about how this works. In a nutshell, the secondary market is where your lender might sell your mortgage after you close on the loan. The ability to offload mortgages allows lenders to turn around and originate more loans.
Because changes in the secondary market can affect borrowers, it’s a good idea to understand the basics. Here’s what to know.
What Is the Secondary Mortgage Market and How Does It Work?
The secondary mortgage market is a marketplace where lenders sell mortgages and investors buy financial products backed by those mortgages. About two-thirds of home loans originating in the U.S. are sold here, according to data from the Credit Union National Association. Here’s a quick example of how it works:
Let’s say a bank uses its reserves to fund mortgages that are collectively worth $10 million. “That kind of ties up their funds to be able to do more loans,” says Jordan van Rijn, senior economist for the Credit Union National Association. “But if they can sell those mortgages to the secondary market and recoup that money, they can go ahead and keep originating more loans.”
Entities such as Fannie Mae, Freddie Mac, and private firms buy those loans and package them into mortgage-backed securities. Then, investors from all over the world buy those products and keep the cycle going.
The average homebuyer might not know about the secondary market, says Nicole Rueth, producing branch manager with the Rueth Team of Fairway Independent Mortgage Corp. “Unless it fails,” she says. “It’s kind of like, I don’t need to know how a car engine works unless the car doesn’t start.”
But it’s good to understand the basics because changes in the secondary marketplace can occasionally impact you. For example, Fannie Mae and Freddie Mac attached a new fee to some refinance loans in late 2020, and many lenders decided to pass on that fee to homebuyers. “That’s a move on the secondary market that immediately ripples to the end user,” Rueth says.
Secondary Mortgage Market vs. Primary Mortgage Market
The primary mortgage market is probably already familiar to you. It’s where borrowers can take out a mortgage loan from a lender, such as a bank or credit union. The lender then extends money to the homebuyer.
After the lender closes several mortgages, it has two options.
- Keep the home loans in its portfolio: Collecting interest from those mortgages offers investment diversification.
- Sell the home loans in the secondary market: Recouping the money helps banks and credit unions fund loans for more borrowers. “Banks tend to sell close to half of their mortgages to the secondary market,” van Rijn says. “Credit unions tend to hold on to a greater share of their mortgages. They sell about 25%.”
Before the secondary mortgage market was established, loans stayed on the primary market. Only larger banks had enough cash to fund mortgages for the entire loan term, and the lack of competition meant lenders could charge higher interest rates. This locked many people out of the homebuying process.
The U.S. Congress created the secondary market in 1938 to “help increase the liquidity,” Haynie says, “and it also helped banks and lenders lower interest rates and manage credit risk. Now it’s evolved to a point where the mortgage market is extremely liquid because you’re able to tap capital from around the world.”
Here’s a quick overview of what happens in each marketplace and who’s involved:
|Primary market||Secondary market|
|• Borrowers take out mortgages from lenders.|
• Lenders, such as banks and credit unions, either sell loans to the secondary market or keep the loans on their books.
• Mortgage brokers help connect borrowers and lenders.
|• Lenders package and sell home loans in the secondary market.|
• Mortgage aggregators buy and securitize the loans.
• Securities dealers and brokers sell the securitized loans.
• Investors buy the securitized loans and receive income from the interest.
Who Buys Loans in the Secondary Market?
Mortgage buyers on the secondary market fall into three main categories:
- Government-sponsored enterprises (GSEs): Fannie Mae and Freddie Mac purchase conventional loans on the secondary market. If lenders plan to sell a loan to Fannie Mae or Freddie Mac, they’ll need to ensure the borrower and the loan meet certain “conforming” requirements set by those agencies.
- Government agencies: Government-backed loans, such as FHA loans, VA loans and USDA loans, are put into mortgage-backed securities through Ginnie Mae, which is a government agency.
- Private entities: Some of these include pension funds, insurance companies, and hedge funds. “Their underwriting criteria may be different from Fannie Mae and Freddie Mac,” Haynie says. “Some investors will specialize in loans where the borrower has a higher debt-to-income ratio, for example.”
What Are Mortgage-Backed Securities?
Mortgage-backed securities are bonds that are secured by homes and other real estate loans. When banks and credit unions fund mortgages, they can choose to bundle them and create mortgage-backed securities. The financial institution then sells these MBS to private and government-sponsored entities on the secondary market. From there, the entities use the MBS as collateral to create new securities. Investors from around the world can purchase these investments.
Most of those “entities” are U.S. government agencies, such as Ginnie Mae, or government-sponsored agencies, such as Fannie Mae and Freddie Mac. The security is backed by the value of the underlying loans. When homeowners pay their monthly mortgage payment, the bondholder ultimately receives some of the interest and principal. Whatever organization issued the security will guarantee the investment and distribute interest and principal payments.
Generally, if banks impose reasonable lending standards and borrowers pay their mortgages on time, the system works.
“Most people pay their mortgages,” Haynie says. “Except when you have really bad economic events—but even then, the majority still pay their mortgages. So it’s a fairly safe form of credit from an investment perspective.”
Can You Control Which Market Your Loan Is In?
Homebuyers don’t have much control over where their mortgages go after closing day, van Rijn says. But you can choose a good mortgage lender at the beginning of the process. While you’re shopping for home loans, “you can always ask the lender if they plan on selling your loan,” van Rijn says. “If that’s important to you, then you can always go with the one that’s going to keep it local.”
If you choose a lender that does sell your mortgage on the secondary market, the lender will contact you and tell you who owns the loan. You will also learn about your loan servicer, which is a company that collects your payments, keeps track of your balance, and reports your account information to the credit bureaus.
“The main thing for borrowers to know is that the manager of your mortgage could change,” van Rijn says. “Who you contact to make payments, ask questions, or file a dispute, that can change—so that’s very important to know.”
If you’re unsure about where to send your mortgage payments, you can always check your credit reports at AnnualCreditReport.com. You’re eligible to pull a credit report from Experian, TransUnion, and Equifax once a year for free. The name and contact information of the company that services your loan should be listed on those reports.
When it comes to home loans, most borrowers don’t know that “a lot happens behind the scenes,” Rueth says. Because the secondary market drives much of the behavior in the primary market, it’s good to know the basics. While you’ll close a home loan with your lender and write checks to your loan servicer, the money typically goes to many different investors who own your mortgage or a piece of it. Understanding the process can make you a more informed buyer—and that’s always a good thing.