How the Secondary Mortgage Market Works

Secondary mortgage markets are private investors and government agencies that buy and sell real estate mortgages. The difference between primary and secondary markets is that secondary markets buy real estate loans from all over the country as investments, whereas primary markets are usually local in nature, with local lenders, making local loans. Secondary mortgage markets were originally established by the federal government in an attempt to moderate local real estate cycles.

The function of secondary markets is the buying and selling of mortgages from primary market lenders. Loans are bought and sold for several reasons. Primary and secondary markets, both, are trying to maximize returns on investment dollars. As interest rates rise, it is more profitable to sell older loans with lower interest rates so the lender has new money to lend again at higher interest rates. In addition to giving banks more money to lend, the secondary markets also can help in other ways. One way is that when local banks invest surplus funds in real estate investments from other regions of the country, the efforts of local real estate cycles can be moderated as the banks also have stable investments from other areas that may be going through different phases of the real estate cycle. Another important by-product of secondary mortgage markets is the standardization of loan criteria. Any changes implemented by secondary mortgage markets become requirements around the country for those wanting to sell mortgages in the secondary market. A good example of this is Fannie and Freddie Mac, the two largest investors in the secondary market. These two companies are so large that a “conforming loan” is typically defined as a mortgage that meets the underwriting standards of Fannie Mae. Of course, both Fannie and Freddie got into a lot of trouble recently for their role in the sub-prime mortgage crisis and overall real estate bubble.

The Federal National Mortgage com buy to let mortgages Association (Fannie Mae) is the nation’s largest investor in residential mortgages. The company is able to purchase conventional mortgages as well as FHA and VA mortgages. Currently under control of the Federal Housing Finance Agency (FHFA), Fannie has been promised billions of dollars of capital as needed by the U.S. Department of the Treasury to ensure the company continues to provide liquidity to the housing and mortgage markets. The company funds its operation by securitization. Securitization is the act of pooling mortgages and then selling them as mortgage backed securities. Conventional mortgage backed securities may be guaranteed by Fannie as to full and timely payments of both principal and interest. Fannie Mae buys mortgages or interests in a pool of mortgages from lenders. Lenders who wish to sell loans to Fannie, must own a certain amount of stock in the company. The lender assembles a pool of loans, and then a participation interest in that pool is sold to Fannie. In this way, both the lender and Fannie Mae own an interest in the loans. Loans sold into the secondary market are usually serviced by the originating lender or another mortgage servicing company. Secondary mortgage market investors pays a service fee to lenders who continue to service the loans.