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Primary vs. Secondary Mortgage Markets: Definition & Differences

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  • 0:01 The Two Mortgage Markets
  • 0:42 Primary Mortgage Market
  • 2:02 Secondary Mortgage Market
  • 3:51 Role of Secondary Markets
  • 5:14 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley

Shawn has a masters of public administration, JD, and a BA in political science.

Mortgage markets are not only important for borrowers and lenders, but they also play an important role in the world of investment. In this lesson, you'll learn about the primary and secondary mortgage markets in the United States.

The Two Mortgage Markets

Francine is looking to buy a home, but she needs a loan. Whether she realizes it or not, she'll be entering the primary mortgage market to do business. The primary mortgage market is where loans are created. However, there is another mortgage market that Francine won't be dealing with directly, but that will still have an impact on her loan. We call this market the secondary mortgage market, which is where lenders can sell their loans to interested parties. Let's look at bit closer at each of these mortgage markets to see how they work.

Primary Mortgage Market

Francine will be heading to the primary mortgage market where borrowers and mortgage originators meet and negotiate to create a mortgage loan. It is where loans are originated. Loan origination is a fancy word for the process of creating a new loan.

Many different parties participate in the primary mortgage market. Borrowers obviously are in the market looking for money, but there are also several types of loan originators who will work with the borrower to create a real estate loan.

Originators include mortgage brokers, mortgage bankers, commercial banks and credit unions. A mortgage broker is someone who brings together borrowers, like Francine, and lenders who want to loan money. A mortgage banker is a person or institution that specializes in providing mortgage loans and usually sells them soon after. Your typical commercial banks, like your typical hometown bank, and credit unions also originate mortgage loans.

Francine ends up working with one of the large commercial banks in town. Her loan officer helps her through the origination process, and she is approved for a loan sufficient to buy the house she wants. Several months after closing, Francine gets a bit of a surprise in the mail. Her bank has sent her notice that her loan has been sold to someone else who she now has to pay instead.

Secondary Mortgage Market

Francine's lender, her bank, never intended to keep the loan. It used warehouse lending to obtain the funds for the loan. Warehouse lenders are financial institutions that loan money to mortgage originators. In other words, the bank borrowed money from the warehouse lender to turn around and loan it to Francine.

Importantly, the bank is making its money off the loan origination fees rather than from holding the loan for the interest. An origination fee is generally a percentage of the loan value paid to the originator, somewhat like a sales commission. The bank sold Francine's loan as quickly as possible so it could pay back the warehouse lender, which frees up its credit with the warehouse lender for more loans to earn more origination fees.

Where does the bank sell Francine's loan? The loans are sold on the secondary mortgage market, where the mortgage originators, like Francine's bank, can sell their loans to investors or mortgage aggregators. A mortgage aggregator is someone who buys a bunch of mortgages and securitizes them, or turns them into a security. The mortgage aggregator securitizes them into mortgage backed securities (MBS), which are sold to investors much the same way an investor may buy a corporate or municipal bond. While a corporate bond involves investing in a corporate debt, and a municipal bond is about investing in government debt, a mortgage backed security is about investing in mortgage debt. In a sense, the investor becomes the lender, and her investment does well or poorly depending upon whether borrowers of the mortgage loans underlying the MBS, like Francine, pay on their loans or default.

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