Once you have secured a loan to buy your new house and begin making mortgage payments, you may not pay the same institution for the entire life of your loan. This is because of the secondary mortgage market. Financial institutions buy and sell loans all the time for various reasons. Though the secondary mortgage market has no direct impact on your loan – other than the name of the bank servicing it – it’s best to be informed about every step of the home buying process. In our last post, we overviewed the primary mortgage market. Today we’ll do the same for the secondary mortgage market.
The Primary vs. Secondary Mortgage Markets
The primary mortgage market is where mortgages begin, before they’re sold to investors in the secondary mortgage market. In the primary market, primary lenders provide loans to everyday borrowers like you. Primary lenders include mortgage bankers, mortgage brokers, commercial banks, credit unions, and savings and loan associations.
Once you’ve secured a loan from a primary lender, the terms for your mortgage are set in place. You’re unlikely to feel the impact of your loan changing hands in the secondary mortgage market. But trust us, a lot is going on behind the scenes.
How Does the Secondary Mortgage Market Work?
Your lender could collect monthly payments on your loan and use that money to pay off the loan over time. But doing so, their capital would be tied up in a limited number of loans. Instead, if they sell them, they regain access to their capital and can decide how to redeploy those funds.
Thus, many lenders choose to sell their loans or servicing rights to third-party investors, like government-sponsored enterprises (GSE) or private investment firms. The most notable GSEs are Fannie Mae and Freddie Mac. These are two companies established by Congress to provide stability and liquidity to the housing finance system in the US. They buy mortgages from lenders, package them into securities, and sell them to investors. By doing so, they free up capital for lenders to make more loans, which helps stimulate the housing market.
In addition to GSEs, private investors (banks, hedge funds, and other financial institutions) participate in the secondary mortgage market. This is because it offers the potential for higher returns than other types of investments, such as stocks or bonds.
Rocket Mortgage outlines how the secondary mortgage market works in a simple four-step process:
Benefits of the Secondary Mortgage Market
If the secondary mortgage market didn’t exist, “mortgage rates would be much higher than they are and most people wouldn’t be able to afford to buy a home,” according to Investopedia. That’s good news. You benefit from the secondary mortgage market, even if you’re not directly engaging in it.
Who else benefits? Lenders are able to regain access to their liquidity, so they can continue to issue new loans. Investors can make higher returns on real estate than other types of investments. And the economy as a whole benefits from this cycle of buying and selling mortgages.
Risks of the Secondary Mortgage Market
Any investment involves risk. The biggest risk is the potential for default, or failing to make required interest or principal repayments on a debt. If a borrower stops making payments on their mortgage, the investor who owns the mortgage will suffer a loss. That’s why there are parameters to qualify for a loan.
The subprime mortgage crisis of 2008 highlighted some of the risks of the secondary mortgage market. Many lenders had issued mortgages to borrowers who couldn’t afford them. When the housing market crashed, many of these borrowers defaulted on their loans. This means they couldn’t pay them off. This caused a wave of foreclosures and resulted in significant losses for investors who had purchased these mortgages on the secondary market.
In response, Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 to impose new regulations on the financial industry, including rules for – you guessed it – the secondary mortgage market. For example, it requires lenders to verify a borrower’s ability to repay a mortgage and prohibits certain types of risky lending practices.
That is why loans sold to agencies like Fannie Mae and Freddie Mac must “conform” to certain standards. In most cases, your lender will check your credit score, require a down payment relative to the size of the loan (typically at least 3 percent), and assess your debt-to-income ratio – all to assess the risks of lending to you.
Fannie Mae and Freddie Mac also cap the loan amount they are willing to back, which can be a struggle for the high real estate costs in the Bay Area. However, the San Francisco Chronicle recently reported that, “For the first time ever, the federal government will back mortgages in the Bay Area over $1 million.” The baseline limit in most parts of the country will be $726,200 in 2023, but extends up to $1,089,300 for single-family homes and condos in all Bay Area counties except Napa, Sonoma, and Solano. The limits in those three counties are a bit lower, but still higher than the national average.
The Secondary Mortgage Market and You
You can thank the secondary mortgage market for making home buying more accessible and affordable for many Americans. As primary lending institutions sell loans and servicing rights to GSEs and private investors, they can continue to create more loans for home buyers. There are risks involved, such as the potential for default, but investors are attracted to the secondary mortgage market because it offers the potential for higher returns than other types of investments. The government has put regulations in place to protect borrowers, lenders, and investors.
As you begin researching your mortgage options, it can be overwhelming, but Willowmar Real Estate is here to help. We can connect you with a network of providers and sit down one-on-one with you to discuss your questions. Contact us today.
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