Secondary mortgage market
Where existing loans are bought and sold by investors and institutions that did not originate them. Selling loans here frees up lenders' funds to make new loans.
Key Takeaways
- The secondary mortgage market is where loans that already exist are bought and sold by investors and institutions that did not originate them.
- Selling a closed loan returns the lender's money immediately, so the lender can originate again instead of waiting thirty years to be repaid.
- Fannie Mae and Freddie Mac are the best known buyers; both purchase loans from lenders and package them into mortgage-backed securities sold to investors.
- A sale in the secondary market transfers ownership of the debt. It does not change the borrower's rate, balance, or recorded security instrument.
What It Means
The secondary mortgage market is the resale market for home loans. Nothing is created here. A lender that has already closed a loan sells it to an investor or an institution that had nothing to do with making it, and that buyer collects the payments from then on. Sales happen one loan at a time and by the thousand, and most borrowers never learn their loan changed hands until a notice arrives telling them where to send the payment.
The market exists to solve a cash problem. A lender that keeps every loan it writes runs out of money quickly, because a thirty-year mortgage returns its principal a little at a time over thirty years. Selling the loan hands that slow stream to somebody who wants it and hands the lender back a lump of cash to lend again. That is what people mean by liquidity in housing finance.
The best known buyers are Fannie Mae and Freddie Mac, which either hold the loans they buy or bundle them into mortgage-backed securities sold to investors worldwide. Private investors buy loans too. Because buyers set conditions on what they will purchase, this market quietly decides much of what the Primary Market can offer a borrower.
How It Works in Washington
Washington does not regulate the secondary market, which is national and largely federal. What Washington regulates is the loan that enters it. A residential loan closed in this state is secured by a Deed Of Trust under chapter 61.24 RCW, and RCW 61.24.020 provides that a deed of trust is subject to all laws relating to mortgages on real property and may be foreclosed by trustee's sale. The security follows the note, so the investor who buys a Washington loan takes those Washington remedies and no others. A student should hear the practical version of that: selling the loan does not convert a deed of trust into something else or move the foreclosure out of state.
The origination end is Washington law as well. Under chapter 19.146 RCW, the Mortgage Broker Practices Act, a mortgage broker is a person who for compensation assists a borrower in obtaining a residential mortgage loan, and RCW 19.146.200 forbids doing that business without a Department of Financial Institutions license. Two labels a licensee meets early describe the loan by the rules it satisfies rather than by who made it: a conforming loan meets Fannie Mae and Freddie Mac purchase standards, and a Qualified Mortgage meets Regulation Z requirements that give the lender certain protections from liability.
Example
Cascade Ridge Lending, a small Everett lender, closes a loan for the Nguyens in April: a $390,000 first mortgage on a $460,000 house, secured by a deed of trust recorded in Snohomish County. Cascade Ridge has $2,000,000 available to lend, so after this loan and four others like it, it is nearly out of money.
In May it sells the Nguyen loan and four more, $1,900,000 of loans in all, to Fannie Mae. The cash comes back and Cascade Ridge starts lending again in June with the same dollars. The Nguyens get a letter saying their loan has been sold and that Cascade Ridge will keep collecting the payment. Their rate is unchanged, their $390,000 balance is unchanged, and the deed of trust recorded in Snohomish County is untouched. The only thing that changed is the name of the party that owns the debt.
Common Mistakes and Exam Traps
- Secondary has nothing to do with lien position. The secondary mortgage market is not a market for second mortgages or junior liens.
- Borrowers do not shop in the secondary market. A buyer applies for a loan in the primary market, where the borrower and the originating lender meet.
- A loan sale changes the owner of the debt, not the terms. An answer choice claiming the investor can raise the rate after buying the loan is wrong.
- Fannie Mae and Freddie Mac buy in this market; they do not lend in it. Mortgage brokers and loan originators work on the origination side, not the resale side.
Where you'll learn this
Frequently Asked Questions
What is the difference between the primary market and the secondary mortgage market?
The primary market is where a borrower and a lender create a loan. The secondary mortgage market is where that finished loan is sold to somebody who did not make it. The same loan often passes through both within a few months.
Why should a real estate broker care where a client's loan ends up?
Because the eventual buyer's standards set the rules the borrower has to satisfy at application. Documentation, debt ratios, and appraisal requirements come from the investor who will purchase the loan, which is why two lenders often ask for the same things.
Who buys the loans traded in this market?
Fannie Mae and Freddie Mac are the best known buyers, and each either holds the loans it purchases or packages them into mortgage-backed securities sold to investors. Other institutions and private investors buy loans as well, which is why the definition says investors and institutions that did not originate the loan.