What Is a Secondary Mortgage Market?

A secondary mortgage market is the market where mortgage loans and servicing rights are bought and sold between mortgage originators, mortgage aggregators (securitizers), and investors. The secondary mortgage market is extremely large and liquid.

Secondary Mortgage Market Explained

The secondary mortgage market is where home loans and servicing rights are bought and sold between lenders and investors. The secondary mortgage market helps to make credit equally available to all borrowers across geographical locations. A large percentage of newly originated mortgages are sold by their originators into the secondary market, where they are packaged into mortgage-backed securities and sold to investors such as pension funds, insurance companies, and hedge funds.

When a person takes out a home loan, the loan is underwritten, funded, and serviced by a bank. Because the bank has used their own funds to make the loan, they will eventually run out of money to loan, so they will sell the loan to the secondary market to replenish their money available to make more home loans. The loan is often sold to large aggregators, such as Fannie Mae. The aggregator then distributes thousands of similar loans in a mortgage-backed security (MBS)

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 a more difficult time finding mortgage lenders. Because there was less competition between mortgage lenders, they were able to charge higher interest rates. The 1968 Charter Act solved this problem by creating Fannie Mae and Freddie Mac two years later. These government-sponsored businesses were 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 mortgages. 

Competition and Risk

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 mortgage-backed securities with low rates. The Federal Government then had to step in to fill the void in the secondary mortgage market. This stopped rates from skyrocketing to a place where hardly anyone could afford to own a home.