Primary vs Secondary Mortgage Market | 2022 Edition

Introduction: What Are Mortgage Loans?

In essence, a mortgage is a loan used to purchase a home. The property secures the loan, and the borrower makes monthly payments to the lender. There are two markets in the United States: the primary mortgage market and the secondary mortgage market. So, what are the major differences between the primary vs secondary mortgage markets?

Ground Zero: The Federal Reserve

The Federal Reserve (also referred to as “The Fed”) is the primary banking system of the United States and controls the flow of money through member banks. It also sets interest rates and regulates the discount rate charged for loans. The Federal Reserve is responsible for maintaining reserve requirements and stimulating the economy through open market operations. 

By controlling the flow of money through member banks and regulating loan discounts, the Federal Reserve exerts tremendous influence over how our economy functions daily. Keeping reserve requirements high and setting a fixed interest rate ensures that there is always a certain amount of money available to meet unexpected demands on the banking system. Engaging in open mortgage market operations helps stabilize prices and promote economic growth.  

The actions of the Federal Reserve have far-reaching implications for both businesses and consumers. For example, if the Fed decides to raise interest rates, this will generally lead to higher borrowing costs for consumers and companies; this could lead to slower economic growth as people cut back on spending. Therefore, when making decisions, the Fed must carefully consider such factors to not unintentionally damage or destabilize our economy.

Discount Rate vs Prime Rate 

The Discount Rate is the rate governments loan money to banks and other financial institutions, and this rate is usually lower than the Prime Rate, which is the rate consumers pay for loans. The reserve minimum is the amount of money member banks must keep meeting their obligations.

Did You Know?

The prime rate is typically higher than the discount rate and generally refers to the rate consumers pay.

Primary Mortgage Market

The primary mortgage market refers to mortgage loan originators who directly provide funding to borrowers to finance a purchase. This income generates from finance charges collected at closing and recurring income collected throughout the loan term.

Mortgage Bankers

A mortgage bank is a state-licensed, commercial banking company that makes mortgage loans directly to consumers. Mortgage bankers originate loans and place them on a pre-established Warehouse Line of Credit until purchase by an investor (typically a large institution), and government agencies absorb the credit risk.

Mortgage bankers have existed in some form since the early 1900s; however, they became more prevalent after the Great Depression to help stimulate home ownership and promote economic stability. Commercial banks play an essential role in our economy by providing access to capital for homebuyers who might not otherwise be able to purchase a home. 

A mortgage banker originates a loan and sells it on secondary mortgage markets. Then, the bank sells these proceeds to a warehouse lender to replenish their lines of credit. In addition to acting as a mortgage originator on primary mortgage markets, most banks also service them once they’ve been sold on the secondary mortgage market – collecting monthly payments from borrowers and passing them along to the investors who own the loans.

Mortgage Brokers

Mortgage Brokers are intermediaries who help individuals or businesses secure mortgage loans from lenders. In many cases, they are the largest sellers of mortgages for lenders.  

Did You Know?

A mortgage banker funds loans with capital as a mortgage loan originator instead of a mortgage broker, who solely connects borrowers with primary lenders.

The primary lender pays mortgage brokers and generally does not charge consumer fees. Mortgage brokers play an essential role in the home-buying process, and they work with potential borrowers and lenders to ensure that everyone gets what they need from the loan agreement. In many cases, brokerages will have an extensive network of potential mortgage lenders with which they can match borrowers—giving them more options than if they went directly to a bank or other financial institution. 

As a middleman, a primary mortgage broker must act ethically and in good faith. Borrowers should feel confident that their broker is working hard to get them the best possible deal while also adhering to all relevant mortgage laws and regulations (including any applicable consumer protection rules).

Banks and Credit Unions

Commercial banks and credit unions are financial institutions that serve the public by providing home loans and deposit services. While both exist in the primary mortgage market, some critical distinctions exist.

For one, banks are for-profit entities, while credit unions are not-for-profit cooperatives. Banks aim to make money for their public or private company shareholders, while credit unions seek to serve their members without making a profit.

On the other hand, credit unions tend to be smaller and have a more limited geographical reach. Finally, you typically need to meet specific eligibility requirements (e.g., working within a particular industry) to join a credit union, whereas anyone can open an account at a bank.

Investment Banking

Investment banking refers to banks’ financial transactions advisory and underwriting services to individuals, corporations, and governments. Investment banks help their clients raise capital, provide assistance with mergers and acquisitions, make markets in securities and derivatives, and trade commodities. 

The investment banking industry divides into three tiers:

• Bulge Bracket firms are the largest and most prestigious firms
• Middle Market firms cater to mid-sized businesses
• Boutique firms specialize in a particular sector or type of transaction

Endowment and Pension Funds

An endowment fund is a pool of money secured (set aside) for a specific purpose by its founders or donors. The corpus value of the endowment typically remains intact, while managers must spend a portion of the fund each year. Most endowments try to keep the principal amount intact while utilizing investment income for philanthropic endeavors. Hospitals, universities, colleges, and other charitable foundations often use endowments as a source of financing for low-risk commercial and industrial properties.

Pension funds are large investment organizations that participate in real estate financing. The Pension Real Estate Association is a nonprofit organization for these investors. Typically, these organizations own funds, have substantial money to invest, and play an essential role in the stock market. Pension funds offer long-term stability and predictable cash flows, making them ideal partners for developers seeking project financing. This funding type is the largest have any category of institutional investing branches.

Insurance Companies

Insurance companies exist to protect people from financial losses by transferring some of the policyholder’s risk to the insurer. In exchange for this protection, policyholders agree to pay a premium. The size of the premium will depend on various factors, such as the amount and type of coverage needed, as well as the insurer’s risk assessment. Insurance companies invest premiums in different ways to cover claims and expenses while making a profit. Some insurers focus mainly on investments, while others emphasize underwriting new policies.  

Secondary Mortgage Market

The secondary mortgage market exists due to Government-Sponsored Enterprises (GSEs) increasing loan opportunities for homebuyers following the Great Depression. These organizations buy mortgages from primary lenders, holding them either in their portfolios or packaging them into securities that other investors buy. By doing so, GSEs play a critical role in providing liquidity to the secondary mortgage market, helping make homeownership more accessible and affordable for borrowers.

The government-sponsored enterprises include:

• Fannie Mae
• Freddie Mac
• Ginnie Mae
• Farmer Mac

Fannie Mae (Federal National Mortgage Association)

Fannie Mae is a government-sponsored enterprise founded in 1938. The organization’s primary purpose is to purchase existing mortgages from lenders, use them as collateral for Mortgage-Backed Securities (MBSs), and sell them on the global market.

Did You Know?

Many people are unfamiliar with the title “mortgage aggregator,” but they are key players in the industry! A mortgage aggregation involves purchasing loans from financial institutions and securing them into mortgage-backed securities (MBSs).

Since the 2008 Financial Crisis and Great Recession, the Federal Housing Finance Agency (FHFA) has overseen the organization. By buying mortgages from a primary lender and then selling them as securities on the global market, the enterprise makes many loans (including those with low closing costs) available for new home purchases and refinancing opportunities.

The types of loans that Fannie Mae buys from lenders include conventional loans, which are not insured or guaranteed by any government agency; FHA-insured mortgages; and VA-guaranteed mortgages. These include two well-known loan products: the fixed rate mortgage and adjustable rate mortgage.

Freddie Mac (Federal Home Loan Mortgage Corporation)

Freddie Mac is a government-sponsored enterprise created in 1970 to help ensure a stable and affordable supply of mortgage funds. The enterprise does this by buying loans from primary mortgage lenders and either holding them in its portfolio or packaging them into securities sold to investors. These purchases allow primary lenders to free up capital to make more loans, which helps keep interest rates low for home buyers. 

Additionally, Freddie Mac offers various programs and initiatives to help low- and moderate-income borrowers obtain financing from a primary mortgage lender. For example, the Home Possible® program offers flexible credit history requirements and down payment assistance so more people can qualify for a mortgage loan.

These programs provide liquidity for mortgages by allowing investors to buy and sell more mortgages and securities backed by pools of loans, helping ensure that lending options are available even when the primary market slows down or dries up completely. 

Ginnie Mae (Government National Mortgage Association) 

Ginnie Mae, founded in 1968, deals in special assistance loans; however, it does not buy or sell loans or issue mortgage-backed securities. The program administers special-assistance programs and guarantees investment securities issued by organizations such as banks and mortgage companies and backed by pools of insured or guaranteed mortgage loans (utilizing a pass-through certificate). This guarantee allows primary lenders to provide financing to home buyers who might not otherwise qualify for a mortgage loan.

The organization traces its roots back to the National Housing Act of 1934 during the recession, which created the Federal Housing Administration (known for the FHA loan and FHA mortgages)—another important agency involved in promoting homeownership opportunities across the country. Today, the organizations deal directly with expanding access to affordable housing finance options through single-family and multi-family housing programs.

Farmer Mac (Federal Agricultural Mortgage Corporation)

Farmer Mac is a Department of Housing and Urban Development (HUD) division founded in 1988. It guarantees payment of principal and interest on loans that it purchases from agricultural lenders, which allows those lenders to pool their loans for sale in secondary mortgage markets. Farmer Mac also provides credit enhancement for certain eligible rural housing loans made by private-sector lenders under Section 538 of the Rural Housing Act. The corporation’s mission is to increase access to capital for (and thus issue mortgages to) farmers, ranchers, and rural home buyers by providing timely financing at reasonable mortgage rates. These rates come with lower closing costs and fees than other lenders who may demand a maximum monthly payment.

Since its inception thirty years ago, Farmer Mac has evolved into a sophisticated issuer of debt securities guaranteed by the United States government with a unique focus on supporting American agriculture. Farmer Mac holds over $24 billion in assets covering nearly every aspect of agricultural lending, including real estate mortgages, equipment finance; livestock finance; working capital lines of credit; crop insurance premium financing; and other rural homeownership and agribusiness loans.

Primary vs Secondary Mortgage Market Conclusion

As you can see, there are many differentiating aspects of the primary versus secondary mortgage market. The primary mortgage market is where mortgage loans originate from entities such as banks, brokers, investment funds, and other financial institutions. Secondary mortgage markets are where those loans are bought and sold by government-sponsored enterprises (GSEs), such as Fannie Mae and Freddie Mac, and private investors. The purpose of the secondary market is to provide liquidity for more mortgage loans and to ensure that new loan financing is available even when the primary market slows down or dries up completely.

Government agencies help make homeownership possible for Americans by guaranteeing certain types of mortgages. This guarantee allows primary lenders to provide financing to borrowers who previously may not have qualified for a home loan (often with a lower interest rate or lower fees), making it possible for more people to achieve the dream of homeownership.

The primary and secondary markets are integral parts of the economy and play a crucial role in helping buyers achieve the goal of homeownership. What are your thoughts on our financial institutions? Contact us or share in the comments below!