The secondary market and participants provide stability for home financing in what way?

Fannie Mae and Freddie Mac 

Fannie Mae and Freddie Mac were created by Congress. They perform an important role in the nation’s housing finance system – to provide liquidity, stability and affordability to the mortgage market. They provide liquidity (ready access to funds on reasonable terms) to the thousands of banks, savings and loans, and mortgage companies that make loans to finance housing.

Fannie Mae and Freddie Mac buy mortgages from lenders and either hold these mortgages in their portfolios or package the loans into mortgage-backed securities (MBS) that may be sold. Lenders use the cash raised by selling mortgages to the Enterprises to engage in further lending. The Enterprises’ purchases help ensure that individuals and families that buy homes and investors that purchase apartment buildings and other multifamily dwellings have a continuous, stable supply of mortgage money.

By packaging mortgages into MBS and guaranteeing the timely payment of principal and interest on the underlying mortgages, Fannie Mae and Freddie Mac attract to the secondary mortgage market investors who might not otherwise invest in mortgages, thereby expanding the pool of funds available for housing. That makes the secondary mortgage market more liquid and helps lower the interest rates paid by homeowners and other mortgage borrowers.

Fannie Mae and Freddie Mac also can help stabilize mortgage markets and protect housing during extraordinary periods when stress or turmoil in the broader financial system threaten the economy. The Enterprises’ support for mortgage lending that finances affordable housing reduces the cost of such borrowing.

Fannie Mae was first chartered by the U.S. government in 1938 to help ensure a reliable and affordable supply of mortgage funds throughout the country. Today it is a shareholder-owned company that operates under a congressional charter.
Fannie Mae Web Site
Fannie Mae Charter Act

Freddie Mac was chartered by Congress in 1970 as a private company to likewise help ensure a reliable and affordable supply of mortgage funds throughout the country. Today it is a shareholder-owned company that operates under a congressional charter.
Freddie Mac Web Site
Freddie Mac Charter Act

Within the secondary mortgage market, there are several major players. Here’s what you need to know.

Mortgage Originators

The mortgage originators create the home loans. Without the mortgage originators, the secondary mortgage market could not exist.

Once the loans are originated, the mortgage originators can choose to sell it or the servicing rights in the secondary market.

Government Sponsored-Enterprises (GSE)

Government-sponsored enterprises (also called GSEs) are not mortgage originators because they don't lend money directly to the public. However, GSEs do guarantee third-party loans and purchase loans within the secondary market.

The purpose of GSEs buying mortgage loans in the secondary marketplace is to ensure liquidity for mortgage originators. This liquidity allows for lenders to continue providing borrowers with access to the loans they are seeking.

Once the GSEs buy the mortgages, they can group the collection of mortgages into securities and sell them to investors. Two major names in this space are Fannie Mae and Freddie Mac.

Sometimes mortgages are purchased directly by the government itself. This is the case with FHA and VA loans.

Investors

Investors in the secondary mortgage market are seeking to buy mortgage-backed securities. Many investors are interested in this opportunity based on the security of the loan attached to a worthwhile interest rate.

Homeowners

As a homeowner, you may not think that the secondary mortgage market will impact you too much. And in general, you are correct. But without homeowners, the secondary mortgage market could not exist.

Ever wonder what happens to your mortgage money after you’ve paid it? It’s possible that it ends up in the secondary mortgage market. A large percentage of mortgages in the U.S. are a part of this market, which helps lenders make loans so more people can fund their homes. Without it, buying a home would be more difficult.

Read on to learn what the secondary mortgage market is, how it works and its risks and benefits.

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What Is The Secondary Mortgage Market?

The secondary mortgage market is where lenders and investors buy and sell mortgages and their servicing rights. It was created by the U.S. Congress in the 1930s. Its purpose is to give lenders a steady source of money to lend, while also alleviating the risk of owning the mortgage.

With this regular movement of money, it’s easier to maintain a stable residential mortgage market.

 In the primary mortgage market, the borrower interacts directly with their lender to receive financing for their home. After the borrower closes on their new home, the lender may sell the loan to a third-party investor, which represents the secondary market. But who are those investors?

Who Are The Major Participants In The Secondary Mortgage Market?

The key participants in the secondary mortgage market are mortgage originators, buyers, mortgage investors and homeowners. Mortgage originators, or lenders, create the mortgages, then can sell the servicing rights on the secondary mortgage market.

Buyers, like government-sponsored enterprises (GSE) Fannie Mae and Freddie Mac, will bundle large groups of mortgages into securities and sell them to mortgage investors. These mortgage investors include investment banks, hedge funds and pension funds.

If you’re a homeowner with a mortgage, you could also be a participant in the secondary mortgage market. Depending on who originated your loan, the money to fund your home purchase could’ve come from this market.

If this seems complicated, let’s tease it out and talk about how the secondary mortgage market works.

How Does The Secondary Mortgage Market Work?

The secondary mortgage market works by connecting home buyers, lenders and investors. This connection makes homeownership more possible for the average person. But how does it work, exactly?

Say you apply for a mortgage and your lender approves. You make a bid and close on a home, becoming a proud owner of a new house. Your lender now has less money to lend out because of your mortgage. It can recoup this money by selling your mortgage to a GSE, like Fannie Mae or Freddie Mac, or other financial institutions. Now the lender has more money to loan out to others.

Your mortgage is then pooled together with other mortgages and creates a mortgage-backed security. The buyer then sells these securities to investors from around the world. These can be pension funds, mutual funds, insurance companies and banks.

Investors buy shares of these bundled mortgages because they’re a near-guaranteed source of steady income. This steady income comes from homeowners like yourself making regular mortgage payments.

You pay a mortgage servicer – the company that manages your loan – and they send the payment to the financial institution that owns the mortgage. The servicer keeps a percentage of the payment as part of their fee for managing the mortgage.

Benefits Of The Secondary Mortgage Market

What does the secondary mortgage market do for the housing market? The benefits are plentiful. The system encourages the movement of money, which helps borrowers gain access to funding their home buying needs. The secondary mortgage market also keeps mortgage interest rates lower and more consistent.

For lenders, being able to sell mortgages means they can fund more loans. It relieves them of the risk of the loan, and they can still make money on fees.

The buyers can then bundle the mortgages and create securities. Investors who buy these securities can receive a reliable return due to borrowers paying their mortgage payment.

When the system works, there are wins across the board. Retirees have money coming from investment funds, banks have money to loan people and you have access to the money you need to buy a home.

Risks Of The Secondary Mortgage Market

The most notable risk of the secondary mortgage market is what occurred in the 2008 – 2009 mortgage crisis. In this situation, Fannie Mae and Freddie Mac held nearly $5 trillion in mortgages on the edge of defaulting. Other large financial institutions, like Lehman Brothers and Bear Stearns, also had large amounts tied up in mortgages.

Borrowers were in too deep on their mortgages and were not making payments, leading to foreclosures. This crisis caused banks to either capsize or to quickly sell off their mortgages and leave the market altogether. Fannie Mae and Freddie Mac then held 100% of mortgages in the U.S.

So, while the secondary mortgage market can reduce risks, if enough borrowers can’t make their payments, it can cause the system to fall apart. Following a collapse like this, only the most credit-worthy customers can get home loans. These are directly funded by big banks with deep pockets. This reaction limits the types of mortgage loans issued, along with who they’re issued to.

Following the crisis in 2008, it wasn’t until 2013 that banks started to return to the secondary mortgage market. This came with many changes. They made fewer loans and adhered to stricter lending requirements.

The Bottom Line: The Secondary Market For Mortgages Makes Homeownership Possible

The secondary mortgage market is a system of borrowers, lenders, buyers and investors. It encourages the liquidity and availability of money, while minimizing risk for lenders. Like any system, it comes with pros and cons. When balance is achieved, the benefits outweigh the risks.

If you’re a hopeful home buyer, you may soon be an active participant in the secondary mortgage market. Make sure to apply for a mortgage and speak with an expert who can help you understand the ins and outs of your home loan.

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Which of the following best defines the secondary market?

Which of the following is not a participant in the secondary mortgage market?

Which items listed below determine if the payment will go up or down on an adjustable rate mortgage?

Which phrase below describes the meaning of the word contract?