How Mortgages Work and The Players In The Secondary Market

What Is The Secondary Market?

When one applies for a mortgage loan – whether at a commercial bank, savings and loan, or mortgage or finance company – the institution is known as the primary originator of the mortgage. Mortgage brokers will use funds of a mortgage banker or commercial bank to close the loan, and this is done in the form of a warehouse line. Companies that purchase mortgages from primary originators are called secondary originators, as they sell these loans in the secondary market.

Primary originators (mortgage bankers and lenders) group a large number of mortgages together in a “pool” and then sell them off to one of the three main purchasers of mortgage loans: Fannie Mae (FNMA), Freddie Mac (FHLMC) and Ginnie Mae (GNMA).

Once these groups purchase the pools, they break them down into smaller ownership parcels. The principal and interest payments made by individual mortgage holders are then combined to create mortgage-backed securities, which are then sold on Wall Street.  By selling these bonds, FNMA, FHLMC and GNMA replenish their funds in order to buy new pools so lenders can get more money to lend borrowers.

Now, not all loans conform to FNMA and FHLMC guidelines, which is why those loans are known as non-conforming.

Non-conforming loans are pooled together in a process called securitization and are sold as mortgage-backed securities as well.

Who’s Who in the Secondary Market?

Government National Mortgage Association (Ginnie Mae or GNMA) -  a government agency that facilitates the  sale of government-insured loans. Ginnie Mae was created in 1968 by congress and is the primary buyer of insured government loans. GNMA is part of the Department of Housing and Urban Development (HUD), the same department that houses FHA. Government-insured loans are programs developed by the Federal Housing Authority and the Department of Veteran’s Affairs.

Federal national Mortgage Association (Fannie Mae or FNMA) and Federal Home Loan Mortgage Corporation  (Freddie Mac or FHLMC) – a government –sponsored enterprise (GSEs) whose primary purpose is to facilitate the sale of mortgages that are not government mortgages; rather they are conventional mortgages. Fannie Mae was created by congress in 1938 and became private  in 1968. Freddie Mac was created by congress in 1970 and is a congressionally charted corporation. The president appoints the members of the board of directors, who also see the operation of 12 Federal Home Loan Banks.  Both Fannie Mae and Freddie Mac are corporations that are traded on the New York Stock Exchange.

Categories and Types of Loans

There are two categories of loans: conventional loans and insured government loans.

Conventional Loans include:

Conforming Loans – These are available under the guidelines of Fannie Mae and Freddie Mac.

Non-Conforming Loans – These are loans that do not meet Fannie Mae or Freddie Mac guidelines. They are also referred to as jumbo loans and subprime loans.

Insured Government loans are mortgage loans insured by either the FHA or the VA. The FHA was created after World War II to stimulate investing in housing. The VA Guaranty Program was created to stimulate the interest of veterans in owning their homes.

Fannie Mae and Freddie Mac

The largest purchasers of mortgages on the secondary market are Fannie Mae and Freddie Mac. Because Fannie Mae and Freddie Mac are GSEs, their debt obligations are backed by the credit of the U.S. Treasury, which reduces the credit risk for investors and allows these loans to carry a lower interest rate.

These GSEs were created by congress in order to make mortgages available to more people with low to moderate incomes. Since 1968, Fannie Mae has helped more than 63 million people  achieve homeownership. Freddie Mac has purchased more than 35 million mortgages since its inception. These impressive numbers are the reason these are the two largest procurement companies in the United States.  America’s housing financing system is envied throughout the world.

The loan limit for both Freddie Mac and Fannie Mae loans is $417,000 for single-family homes in the United States. This is what defines the “conventional” loans you hear about.  Fannie Mae and Freddie Mac purchase almost  all mortgage loans under $417,000. Loans higher than that amount are called jumbo loans and usually have higher interest rates. These limits change annually and are based on the October-to-October changes in the average home price, published by the Federal Housing Finance Board.

Fannie Mae and Freddie Mac establish the basis for interest rates changed to consumers. They also set guidelines that mortgages must meet in order to be eligible for purchase. These guidelines specify : loan size limits and property specifications; down payment requirements; and qualification specifications of the borrower(s).

If a mortgage meets these guidelines, the loan is a conforming mortgage. Conforming mortgages typically carry a lower interest rate than nonconforming mortgages because the conforming mortgages are easier to sell. Nonconforming mortgages are mortgages that do not meet Fannie Mae or Freddie Mac guidelines.