A primary mortgage market and secondary mortgage market goes hand-in-hand.
A mortgage market works by buying and selling loans; that’s as simple as possible. So you put your finger on your dream house; it’s big, safe, and beautiful. Instantly you’ve imagined raising a family there, with kids playing in the backyard, hosting dinners in the house, and having tea on the patio when the weather is perfect. But you need a hefty loan for this dream to become a reality. That is when you enter the mortgage market.
The process seems simple. You find a mortgage lender, you fill in the application, it gets accepted, and you get the money. Now you must spend years repaying the loan; sounds doable, right? Well, it’s not as simple. Here are some details about the mortgage market you need to be mindful of to get the right loan and house.
Primary Mortgage Market
A primary mortgage market is typically where loans are created. You enter the market looking for a mortgage lender and find one; since it is a new transaction, the lender will be ‘originating’ the loan.
Mortgage banks, brokers, lenders, and credit unions are all part of the primary mortgage market. A mortgage broker is a person who brings together borrowers who are willing to buy loans from lenders. In contrast, a mortgage banker is an institution or an organization that lends a loan and soon after sells it too. The downpayment for primary lenders is usually 10% but could also go as high as 20%. If you’re lucky, you could find one at a cheaper rate.
The economy plays a role in the primary market; if it is booming, it is easier to get mortgage loans. Getting loans could be more complex if it faces low credit or other financial constraints. A decline in the economy also affects the secondary mortgage market.
Secondary Mortgage Market Definition
Where the primary mortgage market directly relates to the borrower, the secondary mortgage market works in the background- as a third party.
Players from the primary market become the middle-man in the secondary mortgage market. So if you bought a loan from a bank, who borrowed it from an organization, and now you have to pay back the loan to the organization, NOT the bank anymore.
The bank, this way, has earned money through loan origination fees, not from interest on the loan. Banks offer loans to borrowers and soon sell them in the secondary market to more prominent companies to retain their funds so that they can also lend out to other customers. The secondary mortgage market participants are mortgage originators, aggregators, and investors.
To begin with, when lenders grant mortgages to property owners, they seldom maintain the loan on their books. Instead, the loans are quickly auctioned off to private companies like Amerinote Xchange or loan aggregators like Fannie Mae and Freddie Mac. In exchange for the loans, the lenders get payment and then use the money to offer mortgages to additional borrowers.
Upon purchasing the loans, the aggregators group them with other mortgages with comparable risk. Mortgage-backed securities (MBS) are those collections of securities. Afterward, investors, including governments, pension funds, insurance companies, and hedge funds, can purchase mortgage-backed securities on the open market.
Although the secondary loan market will be the primary emphasis of this article, it is essential to remember that other forms of debt are also transacted in secondary markets. Debt is packaged and marketed in this fashion for auto loans, credit card debt, and school loans. Additionally, U.S. treasury bills, bonds, and notes are a factor in interest rates in general.
The whole definition process may have sounded confusing to you. Don’t worry; let us explain it using a real-life example and see how the two mortgage markets come into play simultaneously.
Eric has chosen a home he loves and wants to finance it. Naturally, he searches for a mortgage lender and intends to shop around. Unknowingly, It is aiming to enter the primary mortgage market. Amongst the options, he decides to borrow a loan from a big commercial bank. He wants the process to go through and the bank originates the loan.
In no time, he gets the loan to fund his house. A few months later, he receives an email that says that the commercial bank has ‘sold’ the loan to an organization. Eric now has to repay the loan to the organization, NOT the commercial bank. Wait, they sold his loan?
What happened was that the bank used warehouse lending to borrow the loan, sell it to Eric and then sell it to the organization. Warehouse lenders lend money to mortgage originators.
The bank sold Eric’s loan in the secondary mortgage market, where the major participant, the organization- also known as the mortgage aggregator comes into play.
It is an example of how primary and secondary mortgage markets work hand-in-hand.
How Come Banks Market Mortgages?
Mortgages are sold by banks primarily for two reasons: profitability and liquidity.
To comply with legally mandated cash reserve requirements and to have funds accessible for account holders and customers, banks must maintain cash reserves. By releasing their cash through the sale of mortgages, banks may make better withdrawals and provide applicants with loans, including additional mortgages. They also remove the possibility of default and debt. Longer-term, less liquid assets on the balance sheet are converted to cash, the most liquid asset, through the sale of mortgages. The loans that the bank sells also earn them instant commissions.
In contrast, the bank takes decades to collect the mortgage interest it makes throughout your loan. In a nutshell, selling loans is more profitable than clinging to them. Banks may profit by issuing a mortgage and collecting interest for several years. However, they may increase their profits by creating a mortgage, selling it (while receiving a fee), then making more mortgages, selling them, and so forth.
How come Investors purchase mortgages?
Investors purchase mortgages (or mortgage-backed securities) for the same reason they buy most debt securities: income. Specifically, a consistent monthly income from the loan’s interest (or how the mortgage owner makes payments). Institutional investors that offer recurrent prices to account holders and clients, such as pension plans, insurance annuity firms, and mutual funds, may find the regularity of this income to be enticing.
In particular, agency mortgage-backed securities- those that the government or government-sponsored organization insures like Ginnie Mae, Fannie Muqae, or Freddie Mac– are thought to have a high credit quality, frequently more than corporate bonds. However, rates on mortgage-backed securities have been higher than those on other low-risk bonds, such as treasury bonds with similar maturities. Other investors may purchase mortgages to diversify their portfolios and asset allocation. Purchasing mortgages offers a little real estate play.
Types of mortgage market players
There are four types of market players
- Mortgage originator,
- Securities dealer,
The first business active in the secondary mortgage market is the mortgage originator. Retail banks, mortgage bankers, and mortgage brokers are examples of mortgage originators. Mortgage bankers often utilize what is known as a warehouse line of credit to fund loans, whereas banks typically use their regular sources of funding to finalize loans. Most banks and almost all mortgage bankers swiftly sell new mortgages into the secondary market.
One distinction is that, in contrast to mortgage brokers, banks, and mortgages. Instead, mortgage brokers connect banks or mortgage bankers with clients (borrowers) as independent agents on their behalf. However, a mortgage originator may aggregate mortgages for a while before selling the entire package. Alternatively, depending on their size and complexity, it may sell individual loans as they are created.
Risk is associated when an originator stays on a mortgage after an interest rate has been offered and locked in by a borrower. The value of the mortgage in the secondary sale and, ultimately, the profit the originator gets on the mortgage might alter if the mortgage is not concurrently sold into the secondary market when the borrower locks the interest rate.
Mortgage originators that pool loans before selling them frequently insure their pipelines against changes in interest rates. For selling a single mortgage, there is a unique sort of transaction called a best efforts deal that does away with the necessity for the originator to hedge a mortgage. Smaller originators frequently use best efforts transactions. The costs required to initiate a mortgage and the difference between the interest rate provided to a borrower and the premium a secondary market would pay for that interest rate.
The following business in the secondary mortgage market players list is an aggregator. Large mortgage originators known as “aggregators” have connections to Wall Street corporations and GSEs like Fannie Mae and Freddie Mae to create pools of mortgages that they can either securitize into agency mortgage-backed securities (by working through GSEs) or private-label mortgage-backed securities (by working with Wall Street firms), aggregators buy newly originated mortgages from smaller originators and combine them with their originations.
Aggregators must hedge the mortgages in their pipelines, much like originators, from when they agree to buy a mortgage through the securitization process until the MBS is sold to a securities dealer. A mortgage pipeline hedging is challenging because of spread and fallout risk. Depending on how well their hedges work, aggregators benefit from the difference between the price they pay for mortgages and the price at which they can sell the MBS backed by those mortgages.
An MBS is sold to a securities dealer after it has been constituted (and occasionally earlier, depending on the kind of MBS). Most brokerage houses on Wall Street have MBS trading desks. MBS and mortgage entire loans are used inventively by dealers at these desks to sell them as securities to investors. MBSs are commonly used by dealers to structure CMOs, ABSs, and CDOs. In contrast to the underlying MBS or entire loans, these transactions can be designed to have distinct and defined prepayment characteristics as well as higher credit ratings. When buying and selling MBSs, dealers charge a spread and try to profit from arbitrage by structuring specific CMO, ABS, and CDO packages.
Investors ultimately use mortgages. Prominent mortgage investors include foreign governments, pension funds, insurance firms, banks, GSEs, and hedge funds. MBS, CMOs, ABSs, and CDOs offer investors various possible returns based on varied credit quality and interest rate risk levels. Banks, insurance firms, pension funds, and foreign governments frequently invest in highly rated-mortgage products. These investors seek certain tranches of the different structured mortgage agreements due to their repayment and interest rate risk profiles.
Hedge funds invest heavily in structured mortgage products with higher interest rate risk and mortgages with poor credit ratings. The GSEs have the most extensive portfolios out of all mortgage investors. The Office of Federal Housing Enterprise Oversight controls a substantial portion of the mortgage products that investors can purchase.
Primary vs. Secondary Mortgage Market
Now that we’re clear on how the mortgage market works in light of the primary and secondary markets in real estate, we must note both benefits. Funding is provided to borrowers by lenders in the primary mortgage market. A lender accepts a borrower’s application for a loan, originates the loan, and disburses the funds to the borrower. The secondary mortgage market is activated once the borrower has been granted a loan and the deal is finalized.
The lender can keep the loan in its portfolio or sell it on the secondary mortgage market. Borrowers can get mortgages from lenders in the primary Mortgage market. For instance, you may engage in the primary mortgage market by asking for a mortgage quotation at your neighborhood credit union and a few banks. There are no borrowers in the secondary mortgage market. Instead, it is the marketplace where lenders offer loans they have created to investors.
Benefits of Primary Mortgage Market
- Primary lenders are based locally, know the current market trends, and will help you make relevant decisions.
- Since it is a direct relationship between the lender and the borrower, there is room for flexibility too. If the current financial plan doesn’t resonate with the borrower, some tweaks could be made to solve problems.
- There is a low closing cost for loans originating in the primary market because lenders do everything in-house. So there are no documentation and administration fees, which means the deal is closed at an affordable rate.
Benefits of the Secondary Mortgage Market
- Secondary market lenders offer a fixed rate of principal and interest portion and can deliver it long-term for up to 30 years. A rise in investment and insurance costs could affect overall coverage, but the interest portion remains constant.
- The secondary market offers a variety of down payment options through several government-funded programs. If you fit the eligibility criteria and qualify for the loans, you can have little or no down payment options on your mortgage.
- MBS loans increase market liquidity for real estate: A bank could decide against lending money in a specific area, on a particular kind of property, or to a borrower with a detailed credit profile. MBS gives property Owners more excellent borrowing options and more alternatives. A bank can create a loan instead of declining one it holds on its balance sheet and channel it into the MBS The benefits are evident in the RMBS sector, where American homeowners may easily acquire financing with favorable conditions thanks to the secondary market.
- MBS increases market transparency for mortgages: MBS’s values are precise since they trade often. These securities serve as a crucial pricing mechanism as a result. Even lenders originating CRE loans for their balance sheets go to the CMBS market to set loan prices.
- Beneficial condition for lenders: The interest rates for CMBS loans are often better than those that a borrower may get on a conventional commercial loan. CMBS loans often provide fixed interest rates, protecting the borrower against fluctuating interest rates throughout the loan. Deals using CMBS may also have more lenient down payment requirements. CMBS loans typically offer a 75% loan-to-value ratio. Because of this relatively large leverage, the borrower’s net worth and credit history are not subject to the same stringent restrictions.
What are mortgage-backed securities?
When looking for a way to participate in the real estate market without owning real estate, mortgage-backed securities (MBS) may be a desirable choice. They are secondary market assets that are backed by a collection of mortgages. This route often carries little risk and can deliver consistent cash flow. In 1968, the first mortgage-backed securities were made available. Private companies created early securities, but by 1970, the Government National Mortgage Association-now more commonly referred to as Ginnie Mae-was offering government-backed MBS.
Investors now have two options for purchasing MBS:
- MBS Agency: Ginnie Mae, Freddie Mac, and Fannie Mae all issue agency MBSs. These organizations give investors certain guarantees, and their MBS are regarded as reasonably risk-free investments.
- MBS without an agency: A private financial institution, like a bank, issues a non-agency MBS. Loans that are a part of these instruments are frequently riskier, non-conforming loans. The majority of individual investors might choose to avoid making these investments.
How does a secondary mortgage market operate?
An intermediary, like Fannie Mae, Freddie Mac, or a loan acquisition business buys the rights to a loan from the loan originator (the lender) in the secondary mortgage market. The intermediary then bundles the loans according to their riskiness and sells the bundles to investors.
How does the secondary mortgage market profit investors?
In the broadest sense, investors profit in the secondary mortgage market by the spread (difference) between the price they paid for the note and the principal and interest the message would eventually pay.
The secondary market is governed by who?
The Federal Housing Finance Agency (FHFA) in the United States oversees the operations of Fannie Mae, Freddie Mac, and the bank that male up the Federal Home Loan Bank (FHLB) System, which offers mortgage lenders a consistent cash flow. The Consumer Financial Protection Bureau (CFPB), established in response to the 2008 mortgage crisis, upholds regulation against unfair, dishonest, or abusive mortgage lender behavior.
Borrowing loans from mortgage lenders and simply getting a loan from one of the participants is the nature of the primary mortgage market. And this one is a simple procedure too. You simply go to the loan originator, have the application approved, and voila, you’ve been approved for a loan.
The process gets complicated when the secondary mortgage market comes into play; the loan has now been sold to one of the secondary mortgage market participants. You must pay the loan to the aggregator now, not the original mortgage lender you borrowed.