Since the economic and real estate crash, we have all heard a lot of jargon about the real estate industry. One of the terms we have heard often is “secondary market.”
You’ve heard this term a lot because it is heavily tied to housing and the mortgage crisis that started roughly a decade ago and caused serious damage in the U.S. economy, including the real estate industry.
You may have a vague idea of what the secondary market is and what it isn’t. You may even know that it’s tied to institutions like Fannie Mae and Freddie Mac. But could you explain it to your friends? For that matter, could you explain it to yourself?
Lots of consumers think that the secondary market has little to nothing to do with them personally, but this assumption is flat wrong. The truth is, the secondary market impacts virtually all buyer because it impacts the affordability of mortgage loans and the willingness of lenders to create loans. In other words, the secondary market can decide the cost of loans, as well as the availability of loans.
The secondary market is important to anyone who borrowers to purchase a home, but it’s also important to sellers. Because they’ll likely sell to a borrower, sellers are impacted by the secondary market; after all, if mortgages are too expensive or unavailable, sellers may be unable to transfer their property.
Therefore, we’d like to give you a basic overview of the secondary market and explain how it impacts you at the personal level.
What is the “Secondary Market” for Mortgage Loans?
To be fair, the entire market can be fairly complex (which may explain why it’s so little understood) but you can generally break it down into two basic components. (Some would break it into three, with the third being mortgage insurance.) Knowing how these components work together can help you understand the basics of the secondary market.
Primary Lenders: These are the lending organizations that make loans directly to consumers all across the country. The consumers can include individual homeowners, as well as business owners and businesses entities. For many years, primary lenders were the only type of lenders, and they were responsible for virtually all of the mortgage loans that were made. These lenders keep the loans as part of their portfolio, but in the late 1930’s, the market expanded to include the secondary market.
Secondary Market: This component of the market involves buying and selling mortgage-backed securities. Basically, a primary lender makes a loan and money is delivered directly to a consumer. The lender then sells the rights to profit off the loan to other institutions. This selling of mortgages is the secondary market.
Lenders benefit from selling loans on the secondary market because the risk is then transferred to the purchasing company. For example, if Fannie Mae purchases a loan, they assume the profits and the risk, while the lender simply makes a profit for the one-time sale.
There are three major institutions in the secondary market: the Federal National Mortgage Association (Fannie Mae), Federal Home Loan Mortgage Corporation (Freddie Mac), and the Government National Mortgage Association (Ginnie Mae). While these organizations are supported by the federal government, they are companies that have the stated mission of making home loans more affordable and accessible.
The secondary market plays a critical role in sustaining a healthy housing market. Few buyers have the cash on hand to purchase a home outright, so they rely on lenders to help them purchase the house.
The secondary market is also connected to the mortgage insurance market. Secondary markets can’t operate with too much risk, so lenders with smaller down payments (which means higher risk statistically) are required to pay for mortgage insurance, which protects them from defaults on the loan. Although it is a slightly different subject, mortgage insurance helps make loans even more accessible by reducing risk at both the primary and secondary markets.
How Does the Secondary Market Impact Buyers?
You may have never dealt with Fannie Mae, but what they do in the secondary market has a direct effect on your mortgage. For example, Fannie Mae can change its guidelines and revise the types of loans it will purchase. Once this is done, the primary lenders will have to change the types of loans they offer, which means the types of loans that are available to you will change.
Institutions that purchase on the secondary market can also make changes to qualification standards. For example, they can determine that a borrower must have a debt-to-income ratio below 40% or they won’t purchase the loan. Lenders would then be forced to only offer loans to people who meet this criteria, which means you may not qualify for a loan because of a choice made by Fannie Mae officials.
Let’s look at how the secondary market has impacted borrowers in the past…
Secondary Market and You: A Real-World Example
Primary lending is heavily influenced by the secondary market, as was seen in the most recent economic crisis. In the 1990’s and going into the early 2000’s, subprime (aka low credit) loans were given out with little regard to whether or not the borrower could pay. These high-risk loans were given to borrowers and sold to the secondary market, and it’s worth remembering that these loans would not have been made if the secondary market, which removed the risk to primary lenders, didn’t exist.
This easy lending led to numerous defaults, which eventually led to an economic crisis that snowballed through the nation and the globe. Now the major institutions in the secondary market have adjusted their standards to avoid significant, reckless subprime lending, which means that lenders are no longer making loans as freely as they did in, say, 2006. Now, when you visit a lender’s office, you’ll have to go through a more thorough process to prove your borrowing capability.
This is a real-world example of how the secondary market has a direct impact on your mortgage application.
Providing Expert Advice for Your Mortgage Purchase
If you want to learn more about available loans through both the primary and secondary markets, please contact the helpful team at San Diego Purchase Loans.
With a vast knowledge of the real estate industry, and a dedication to providing common-sense mortgage approval, we’ll do our part to help you find the right mortgage loan for your specific needs.
