Legal Definitions - secondary mortgage market

The secondary mortgage market is a financial marketplace where existing mortgage loans and mortgage-backed securities are bought and sold by investors. It operates distinctly from the primary mortgage market, which is where individual borrowers initially obtain loans directly from lenders like banks or credit unions.

In the secondary market, lenders who originated mortgages can sell those loans to other financial institutions or investors. This process allows primary lenders to replenish their funds, enabling them to issue new loans to more borrowers. For investors, the secondary market offers opportunities to purchase income-generating assets, often in the form of bundled mortgages known as mortgage-backed securities (MBS).

• Example 1: Bank Selling Loan Portfolios

  A regional bank, "Coastal Savings & Loan," has been very successful in originating new home mortgages in its community. To ensure it has enough capital to continue offering competitive rates and approving new loan applications, Coastal Savings & Loan decides to sell a large portfolio of its existing, performing mortgage loans to a major investment bank. The investment bank then holds these mortgages as assets, collecting the principal and interest payments from the homeowners.

  This illustrates the secondary mortgage market because Coastal Savings & Loan is selling previously issued mortgage loans to another financial entity. This transaction provides the bank with fresh capital, allowing it to make more new loans in the primary market, while the investment bank acquires existing loans as an investment.

• Example 2: Mortgage-Backed Securities (MBS) Issuance

  A large financial institution, "Global Capital Investments," acquires thousands of individual residential mortgages from various lenders across the country. Global Capital Investments then pools these mortgages together and creates new financial instruments called mortgage-backed securities (MBS). These MBS are then sold to institutional investors, such as pension funds and insurance companies, who are looking for stable, income-generating investments.

  This demonstrates the secondary mortgage market through the creation and sale of MBS. The pension funds and insurance companies are not lending directly to homeowners; instead, they are investing in a security whose value and income stream are derived from a large pool of existing mortgages.

• Example 3: Government-Sponsored Enterprise Purchases

  A small community credit union, "Hometown Credit Union," originates several new 30-year fixed-rate mortgages for its members. To manage its risk and free up capital quickly, Hometown Credit Union sells these newly originated mortgages to Freddie Mac, one of the government-sponsored enterprises (GSEs) that operates in the secondary market. Freddie Mac then either holds these mortgages or bundles them into securities to sell to other investors.

  This example highlights the secondary mortgage market as Freddie Mac is purchasing existing mortgage loans from Hometown Credit Union. This transaction allows the credit union to reduce its long-term risk exposure and provides it with immediate cash, which it can then use to make more new loans to its members in the primary market.