Topic 13.8: Secondary Mortgage Market >

Learning Objective

After successfully completing this topic, you will be able to describe the role of the secondary mortgage market and know the features of the major agencies active in the secondary market.

Effects of the Secondary Mortgage Market 

Years ago, depository lenders kept their mortgage loans in their own portfolio. The sources of funds for originating the loans came from deposits and mortgage repayments. When the loans exhausted their funds, they could make no more loans.

Today, most mortgage lenders sell the loans they originate in the secondary mortgage market. The proceeds from the sale of the loans give the lender the funds necessary to originate new loans. The process circulates the supply of mortgage money.

Intermediation and disintermediation

When persons put their funds into a depository, such as a bank or savings association, the depository then lends the money to borrowers who need the funds. The depository is an intermediary, and the process is called intermediation. When those persons remove their funds to buy property or stocks, the process is called disintermediation.

Standardizes loan requirements

The secondary market works most efficiently because loan documents such as mortgage applications, appraisal forms, and mortgages, and closing disclosure are the same. 

Conforming loans

A conforming loan is one that meets the requirements to be sold to Fannie Mae, Freddie Mac, or other secondary market buyers. A nonconforming loan is a loan that is higher than the allowed limits (jumbo loan) and cannot be sold to Fannie Mae or Freddie Mac.

Conforming loans are easier to qualify for, have lower interest rates, may have a lower down payment, and give a little more flexibility with the credit score.

Portfolio lenders

Portfolio lenders keep the mortgages they originate in their own portfolio. This is unusual, but may be done for a bank’s good customer who has a nonconforming loan. The real issue for portfolio lenders is interest rate risk; as interest rates increase, the value of the loan decreases. In case the lender has a liquidity problem and must sell the loan later, the lender may have a significant loss.

Fannie Mae

The Federal National Mortgage Association (FNMA), informally known as Fannie Mae, is a government-sponsored enterprise (GSE). Fannie Mae is a private corporation that is supervised by the Federal Housing Finance Agency. Fannie Mae stock is publicly traded in the over-the-counter market. Fannie Mae stimulates the housing market by making more mortgages available.  

Secondary market for FHA, VA and conventional loans

Fannie Mae does not make mortgage loans. Fannie Mae buys FHA, VA and conventional mortgages, usually from larger commercial banks. Fannie Mae is a major factor in the secondary market.

Issues mortgage-backed securities (MBS) to investors

Fannie Mae bundles many loans into a security that investors can buy. The structure of the MBS may be known as “pass-through”, where the interest and principal payments from the borrower or homebuyer pass through it to the MBS holder, or it may be more complex, made up of a pool of other MBSs.

Here’s how it works.

1. Sammy Levito buys a house by borrowing $300,000 and giving an FHA mortgage to Sand Bank. Sand bank has $300,000 less to lend to other borrowers, so after a time it will have to put up a sign saying “Sorry, out of money. No more mortgage applications accepted.” Happily, Sand Bank doesn’t wait until it’s out of money and goes to step 2.
2. Sand Bank sells some of its assets to get cash. It sells $10 million of its mortgages to Fannie Mae. Fannie Mae pays Sand Bank $10 million, so the bank is back in the loan business. But, after a time, Fannie Mae will be out of cash to buy more mortgages and will have to tell the banks it can’t buy any more mortgages. So, Fannie Mae takes action in Step 3.
3. Fannie Mae bundles $100 million in mortgage loans and sells the bundle as a mortgage-backed security (MBS). A large mutual fund buys the bundle as part of its investment portfolio and it gets the principal and interest when Sammy Levito and thousands of other borrowers make their payments.

Government National Mortgage Association (GNMA) 

GNMA guarantees bonds for packages of VA and FHA loans

Ginnie Mae is government owned and financed. It is a part of the Department of Housing and Urban Development (HUD). It guarantees bonds issued by Fannie Mae and Freddie Mac.

Mortgage-backed securities program

Ginnie Mae does not sell or buy mortgage loans. Fannie and Freddie packages thousands of mortgages into bundles with similar interest rate and maturities. Ginnie Mae’s guarantee has the backing of the federal government, helping Fannie and Freddie get a better price when they sell the bundles to investors.

Ginnie Mae mortgage-backed securities are often called pass-through securities, because when loan payments are made, the principal and interest are passed through to the securities investor.

Freddie Mac

Freddie Mac, short for Federal Home Loan Mortgage Corporation, was created by congress in 1970. Freddie Mac buys FHA, VA, and conventional loans, primarily from small banks and savings associations which helps their liquidity.