Secondary Mortgage Market

What Is the Secondary Mortgage Market?

The secondary mortgage market is a marketplace where home loans and servicing rights are bought and sold between lenders and investors. A large percentage of newly originated mortgages are sold by the lenders who issue them into this secondary market, where they are packaged into mortgage-backed securities and sold to investors such as pension funds, insurance companies, and hedge funds.

The secondary mortgage market is extremely large and liquid, and helps to make credit equally available to all borrowers across geographical locations.

Key Takeaways

  • The secondary mortgage market is a market where mortgage loans and servicing rights are bought and sold by various entities.
  • Several players participate in the secondary mortgage market: mortgage originators (who create the loans), mortgage aggregators (who buy and securitize the loans), securities dealers/brokers (who sell the securitized loans), and finally, investors (who buy the securitized loans for their interest income).
  • The secondary mortgage market is extremely large and liquid, and helps to make credit equally available to all borrowers across geographical locations.

How the Secondary Mortgage Market Works

Several players participate in the secondary mortgage market: mortgage originators, mortgage aggregators (securitizers), and investors.

When a person takes out a home loan, the loan is underwritten, funded, and serviced by a financial institution, usually a bank. Known as mortgage originators, banks use their own funds to make the loan, but they can't risk eventually running out of money, so they often will sell the loan on the secondary market to replenish their available funds, so they can continue to offer financing to other customers.

Depending on its size and sophistication, a mortgage originator might aggregate mortgages for a certain period of time before selling the whole package; it might also sell individual loans as they are originated.

The loan or loans is often sold to large aggregators. The aggregator then distributes thousands of similar loans in a mortgage-backed security (MBS). After an MBS has been formed (and sometimes before it is formed, depending upon the type of the MBS), it is sold to a securities dealer. This dealer, often a Wall Street brokerage firm, further package the MBS in various ways and sell it to investors, who are often seeking income-oriented instruments. These investors don't get control of the mortgages, but they do receive the interest income from the borrowers' repayments.

History of the Secondary Mortgage Market

Before the secondary market was established, only larger banks had the extensive funds necessary to provide the funds for the life of the loan, usually for 15 to 30 years. Because of this, potential homebuyers had difficulty finding mortgage lenders. Because there was less competition between mortgage lenders, they were able to charge higher interest rates. 

The 1968 Urban Housing and Development Act solved this problem by reorganizing Fannie Mae into a for-profit, shareholder-owned company. Freddie Mac was established in 1970 with the Emergency Home Finance Act to assist thrifts with managing interest rate risk.

The secondary mortgage market allows loan issuers to continue funding more loans. If this 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.

These government-sponsored enterprises functioned as aggregators, able to buy bank mortgages and resell them to other investors. Instead of reselling the loans individually, they were bundled into mortgage-backed securities, which means their value is secured or backed by the value of the bundle of underlying loans. 

Special Considerations

Competition and risk are always part of the game when private investors bring mortgage loans onto the secondary mortgage market because the private investors begin to drive mortgage rates and fees. This means if you have a low credit score and seek a loan, you can be perceived as risky, so they can charge higher rates and fees.  

After the subprime mortgage crisis, individual investors grew unwilling to risk their capital on low-interest mortgage-backed securities. The federal government then had to step in to fill the void in the secondary mortgage market.

What Is the Purpose for the Secondary Mortgage Market?

This market expands the opportunities for homeowners by creating a steady stream of money that lenders can use to create more mortgages.

What Is an Example of the Secondary Mortgage Market?

If you purchase a home using a mortgage, your lender might—and most do—sell it to the secondary market to get back the capital they loaned you and reduce lending risks. Depending on the buyer, the mortgage could be held to collect your payments or securitized with other mortgages into mortgage-basked securities for investors to buy.

What Is a Secondary Mortgage Loan?

A secondary mortgage loan is a loan sold on the secondary mortgage market. The practice of selling mortgages allows lenders to continue lending and keep the cost of borrowing down.

Correction—June 30, 2022: A previous version of this article misstated the year that Fannie Mae and Freddie Mac were established.

Article Sources
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  1. U.S. Securities and Exchange Commission. "Mortgage-Backed Securities and Collateralized Mortgage Obligations."

  2. Federal Housing Finance Agency. "A Brief History of the Housing Government-sponsored Enterprises," Page 3.