Primary vs Secondary Mortgage Market: Here’s the Difference
The difference between the primary and secondary mortgage market comes down to how the mortgage industry works on the inside. You can buy a house without ever knowing the difference between the two, but knowing the difference makes you an educated consumer. By the time you’re done reading this article, you’ll have a solid understanding on the primary vs secondary mortgage market.
What is a Primary Mortgage Market?
The primary mortgage market is where a homebuyer secures a loan through a lender. As a doctor looking for a physician mortgage, for example, you are shopping for that mortgage in the primary mortgage market. This market is where loans begin before being sold to investors on the secondary mortgage market.
Mortgage brokers, banks, credit unions and mortgage bankers are lenders in the primary mortgage market, with banks and credit unions being the most common. Mortgage brokers connect you with lenders based on your financial profile and the type of loan you need. Mortgage bankers use their own funds, or funds borrowed from a warehouse lender, to fund your mortgage. And online lending platforms, like a Rocket Mortgage, offer lower mortgage rates because of their lack of physical lending locations. They also make loans directly, but quickly sell them on the secondary market after closing.
How the Primary Mortgage Market Works
Primary mortgage lenders originate loans, close them and sell them on the secondary market. You can think of the primary market as the front of the mortgage process, and the secondary market as the back. Once a mortgage has closed in the primary market, it is packaged up as an investment and sold on the secondary market. When your bank sells your mortgage on the secondary market, they immediately make back the money they lent to you to buy your home. Flushed with cash, your bank will find a new customer to take out another mortgage, and start the process all over again. The flow of mortgages between the secondary and primary mortgage markets helps keep mortgages affordable and widely available.
However, a mortgage lender can’t just give away mortgages to anyone that comes knocking. The primary mortgage market is heavily regulated and lenders must collect specific information from borrowers, conduct due diligence on the property and of course underwrite the loan itself. It is the underwriting part that determines the risk of the borrower and what the appropriate interest rate should be. A mortgage lender must also collect and track required documents, such as deeds and disclosures, to have ready when selling the mortgage on the secondary market.
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Primary Mortgage Market Products
The primary mortgage market is all that most people know. It’s what we read about in the news, talk to our neighbors about and see via “For Sale” signs outside homes. The products available in the primary mortgage market range widely. There is a mortgage product for everyone:
Fixed rate mortgage
This is a loan with a fixed interest rate and monthly payment for the entirety of the loan.
Adjustable-rate mortgage (ARM)
A loan with various interest rates. The rate will start out at as fixed for some time, typically 3 to 10 years, before changing on an annual basis.
Loans not backed by the government, but instead by a private lender with mortgage insurance from a commercial provider.
Conforming mortgage loan
These loans within the funding limits of Fannie Mae and Freddie Mac. Dollar limits are set by the Federal Housing Finance Agency, and are currently set at $647,200 for a single family home.
If a loan exceeds the conforming limit, one of these loans can be used. They’re provided by banks, and loan limits can be as high as several million dollars.
This is a loan with more relaxed requirements, making it easier for a low credit score or a higher debt buyer. All loans are government-backed.
Loans for rural area homebuyers with zero down payment. These cater to lower income buyers who are unable to obtain a traditional mortgage loan.
Catering to those who have previously served or are currently serving in the US military. These loans require zero money down and are backed by the Department of Veterans Affairs.
Physician mortgage loan
Made specifically for those in the medical field. For example: doctors, dentists, and optometrists. These loans make it easier for medical professionals to get loans, taking into account their financial profiles that may include high student loan debt.
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What is a Secondary Mortgage Market?
The secondary mortgage market is where money is made. Investors and lenders buy and sell mortgages to earn profits on the loans and the servicing fees they generate. But who exactly are the investors buying our mortgages on the secondary mortgage market? Fannie Mae and Freddie Mac are the two biggest players. Both Fannie Mae and Freddie Mac were created by the U.S. Congress to compete with one another and provide liquidity to buy mortgages on the secondary market. Banks and mortgage lenders never have to worry about having enough deposits to issue mortgages because the U.S. government is constantly buying mortgages from the banks. Another major player in the secondary market is Ginnie Mae. Much like Fannie Mae and Freddie Mac, Ginnie Mae provides funding for the primary market, but only purchases government-insured loans such as the USDA, VA, and FHA mortgages.
Why We Need the Secondary Mortgage Market
You may be thinking: is the secondary mortgage market necessary if all it does is enrich investors? The short answer is yes. The secondary market creates liquidity in the mortgage market which makes it easier for borrowers to obtain funds for their homes at reasonable interest rates. Lenders are able to sell their mortgages immediately, making it easier to fund more loans without risk, while also earning fees in the process. With the proper balance of lenders, investors, and borrowers doing what they’re supposed to, the benefits of the secondary market will outshine the risks. Banks have funding for loans, borrowers have loans for their homes, and lenders are able to replenish their capital on a continuous basis.
Is the Secondary Mortgage Market Risky?
The main risk of the secondary market is borrowers being unable to pay their mortgages. If enough borrowers can’t make their payments, the system will collapse. An example of this risk factor began in 1999, when lenders like Freddie Mac and Fannie Mae started to make loans more accessible to low credit “subprime borrowers,” not taking into account the higher risk of loan defaults. Subprime borrowers were approved for adjustable-rate mortgages, with low monthly payments that would increase over time. Subprime loans were being sold to commercial investors in large quantities.
2008 brought the Mortgage Meltdown. Large numbers of subprime loans started defaulting, causing the stock market to collapse and creating chaos within the global financial markets. This became known in history as The Great Recession of 2008. After the collapse, Fannie Mae, Freddie Mac and Ginnie Mae tightened mortgage guidelines, and funding became less available. However, safeguards have been put in place since lowering the risk of a repeat of the events of 2008.
If you’re looking to buy a home, or if you are an existing homeowner applying for a refinance, it isn’t critical for you to know the difference between the primary and secondary mortgage markets. But you may hear these terms, and this article will give you a better understanding of exactly what they both means. If nothing else, that’ll make an already confusing process – the mortgage application – a little bit less confusing.