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

Written by Samantha CatheyUpdated: 28th Dec 2021
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Odds are if you currently have a mortgage, it’s been bought and sold on the secondary market without your knowledge.

If you don’t have a home loan just yet, it’ll happen to you someday, too. But how are banks allowed to sell my mortgage? What is the secondary mortgage market? Read on to learn more.

What is the Secondary Mortgage Market?

The existence of a secondary mortgage market suggests there is a primary mortgage market, and there is! Its where you and other consumers secure home loans from banks and other lenders.

Once your loan is secured, however, your lender may keep it and make money off your monthly payments, or it will sell it on the secondary mortgage market.

Most banks can’t wait for all their clients’ monthly mortgage payments to come in to fund their expenditures, and so they sell off a percentage of home loans, servicing rights, and mortgage-backed securities to create more capital to fund more mortgages.

A mortgage-backed security is a pool of multiple home loans with similar characteristics and is a lot like a bond.

Created in the 1930s, the secondary mortgage market cycles trillions of dollars between mortgage lenders, investors and even the government. The secondary mortgage market is massive!

How Does the Secondary Mortgage Market Work?

After you close on your mortgage, your lender likely will sell it, or the associated servicing right, in the secondary mortgage market.

Banks keep about half of their mortgages, capitalizing on interest payments and the diversification of their portfolio.

Credit unions sell fewer of their mortgages than traditional banks do. However, both lenders often retain the servicing rights to their mortgages which means borrowers may not even know their home loan has been sold at all.

  • Primary Market = Mortgage 🡪 Borrower
  • Secondary Market = Mortgage 🡪 Investor

Who Buys Home Loans in the Secondary Mortgage Market?

There are investors, private organizations, and government enterprises that buy loans in the secondary mortgage market. 

Private Investors

Hedge funds, insurance companies, mutual funds and pension funds are charged with growing and protecting their client’s investments.

All participate in the secondary mortgage market, though they have different underwritingstandards than government agencies and enterprises.

If accompanied by a broker, individual investors are welcome on the secondary market, but even though mortgage-backed securities are a relatively safe investment, they are complicated financial instruments and should only be handled by experienced investors.

Government Sponsored-Enterprises (GSEs)

The government sponsored-enterprises, Fannie Mae (FNMA) and Freddie Mac (FHLMC) are different organizations, but they participate in similar activities.

Both purchase mortgages to help provide a consistent and stable source of home loan funding for the everyday consumer.

These enterprises purchase only conventional home loans that meet certain standards surrounding loan amount and down payment figure, as well as borrower credit score, loan to value ratio, and debt-to-income ratio.

These are called “conforming loans.” Fannie Mae and Freddie Mac guarantee the bonds they sell to other investors, which means if homeowners default on their underlying mortgages, the GSEs are still on the hook for their investor’s monthly payments.

>> More: Fannie Mae vs. Freddie Mac

Government Agencies

Not to be confused with a GSE, Ginnie Mae (GNMA) is technically a government agency. The loans it buys from lenders are direct obligations of and backed by the full faith and credit of the U.S. government.

Ginnie Mae purchases government-backed home loans like those from the VA, FHA, and USDA.

Mortgage Originators

Lenders like banks, credit unions, and private mortgage companies are all considered mortgage originators.

A bank will choose to either keep a new home loan in its portfolio and make money by collecting origination fees and interest, or it will sell the mortgage on the secondary mortgage market.

Mortgage originators purchase home loans and securities from other lenders as well to diversify their portfolios.

>> More: How to Choose the Best Mortgage Loan

Does the Secondary Mortgage Market Affect Mortgage Rates?

According to Credit Union National Association, about two-thirds of all mortgages are eventually sold on the secondary mortgage market. How does the market affect current mortgage rates?

The secondary mortgage market affects the rate you pay and the standards you are kept to when applying for a home loan.

In fact, whether an online mortgage lendereven deems it necessary to give out loans at the time is based on movements in the secondary mortgage market.

When the economy is doing well, investors generally wait to purchase investments so they can lock in higher yields, which in turn drives mortgage interest rates up.

Conversely, when the economy is starting to drag, investors move quickly to buy what’s available to avoid even lower yields later. This pushes interest rates for home loans down.

Furthermore, without the secondary mortgage market, only large banks were previously capable of funding the entire term of a mortgage, so they were able to charge higher interest rates due to minimal competition. People were constantly priced out of getting a home loan.

>> More: How to Get Mortgage Preapproval

Understanding Mortgage-Backed Securities

A mortgage-backed securityis simply a bond comprised of multiple mortgages with similar characteristics.

Such deciding factors might be applicant credit score and loan-to-value ratio, in addition to interest rate and loan term, all of which help determine an MBS’s risk profile. Risky mortgages are grouped separate from less risky ones.

It is through the sale of MBSs that banks and other lenders have the ability to finance millions of home loans at once.

Thousands of mortgages could be packaged into a single bond security. Fannie Mae (FNMA) and Freddie Mac (FHLMC) are huge buyers of MBSs.

What are the Advantages of the Secondary Mortgage Market?

The existence of the secondary mortgage market is hugely advantageous for the overall economy.

It creates liquidity in the housing finance market and enables more people to get home loans while helping maintain lower costs for those borrowers. It also makes longer term loans more feasible, like the ever-popular 30-year fixed-rate mortgage.

There are certain special advantages afforded to investors in the secondary mortgage market as well.

Though investment in mortgage-backed securities should be reserved for sophisticated investors given their complexity, they are a safe investment.

When push comes to shove, most homeowners do whatever it takes to keep a roof over their head. Thus, investors have a reliable stream of returns.

>> More: Fixed vs. Adjustable-Rate Mortgages

What are the Disadvantages of the Secondary Mortgage Market?

Drawbacks of the secondary mortgage market are few, but there are some risks posed to investors as there are with all investments.

For example, prices on the market fluctuate often which can lead to a sudden loss. Additionally, brokerage fees associated with investing in the secondary mortgage market are high relative to the lower returns often afforded to investors.

Bottom Line: What is the Secondary Mortgage Market?

The secondary mortgage market is a vast place and is important in maintaining affordable mortgage rates around the country.

It drives behavior in the primary market because it contains a huge portion of mortgages. Even if you don’t have a mortgage, you could be participating in the secondary mortgage market if your rental payment goes toward the property’s mortgage.

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Samantha Cathey
Samantha Cathey

Samantha Cathey is a Senior Personal Finance Writer & Product Analyst with years of financial training and industry knowledge. She is a former banker, loan officer and investment advisor before dedicating her energy to helping individuals more creatively, through her writing. Samantha studied at the University of Idaho where she majored in Journalism and Writing. Her areas of expertise are mortgages, credit cards, loans, and investing.