Who Buys Mortgages on the Secondary Market?
Understand the key players and functions of the secondary mortgage market, revealing how mortgages are traded and why it's vital for housing finance.
The secondary mortgage market is where existing home loans are bought and sold after they are initially created by lenders. This market operates distinct from the primary market, where borrowers obtain mortgages directly from banks or other financial institutions. Its function is to provide capital to mortgage lenders. By facilitating the sale of mortgages, the secondary market ensures lenders can replenish their funds. This financial ecosystem underpins the broader housing finance system, supporting mortgage credit availability.
Why Mortgages are Traded
Mortgages are traded on the secondary market for reasons that benefit both original lenders and purchasers. For originators, selling mortgages provides immediate capital, which maintains liquidity. This allows them to make new loans to homebuyers, rather than having capital tied up in long-term debt. Selling also helps lenders manage and reduce financial risk from holding large loan portfolios.
Purchasing mortgages or mortgage-backed securities offers investors opportunity for portfolio diversification and income generation. These investments provide a steady stream of income through interest payments from underlying loans. Mortgage-backed securities are considered stable investments, especially those guaranteed by government-sponsored entities. This combination of consistent returns and stability attracts institutional investors seeking predictable income streams.
Government-Sponsored Entities as Buyers
Many mortgages on the secondary market are purchased by Government-Sponsored Entities (GSEs). The two largest GSEs are Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation). These entities do not originate loans directly to consumers but instead buy mortgages from primary lenders. After purchasing, they pool individual loans and package them into mortgage-backed securities (MBS), which are then sold to investors.
Fannie Mae and Freddie Mac also guarantee timely payment of principal and interest to investors holding their MBS. This guarantee enhances the appeal of these securities, making them attractive to a broad range of investors. Fannie Mae primarily acquires mortgages from larger commercial banks, while Freddie Mac typically purchases from smaller thrift institutions and credit unions. Both GSEs play a role in standardizing loan requirements, which helps ensure a consistent flow of affordable mortgage credit across the United States.
Another GSE is Ginnie Mae (Government National Mortgage Association), which operates differently from Fannie Mae and Freddie Mac. Ginnie Mae guarantees MBS backed by loans from government programs, such as those insured by the Federal Housing Administration (FHA), guaranteed by the Department of Veterans Affairs (VA), or offered by the United States Department of Agriculture (USDA). Unlike other MBS, Ginnie Mae securities carry the full faith and credit guarantee of the U.S. Government. This backing provides the highest level of payment assurance to investors, contributing to the liquidity and stability of government-insured mortgage markets.
Private Sector Purchasers
Beyond government-sponsored entities, a diverse group of private sector institutions participates in the secondary mortgage market. These purchasers include large commercial banks, investment banks, insurance companies, and institutional investors such as pension funds and hedge funds. Their motivations for buying mortgages center on achieving specific investment returns, diversifying portfolios, and managing exposure to different financial risks.
Some private entities purchase “whole loans” directly from originators, holding these loans on their balance sheets to collect interest payments. Other private investors focus on acquiring private-label mortgage-backed securities (MBS). These private-label MBS differ from those issued by GSEs because they do not carry a government guarantee, meaning they often involve greater risk. Consequently, these securities may offer higher potential yields to compensate investors for increased risk exposure.
Insurance companies find mortgage loans attractive due to favorable risk-based capital requirements and the potential for stable, long-term income streams. Investment banks may acquire mortgages for securitization purposes, creating complex financial products for sale to other investors. Hedge funds and other institutional investors seek opportunities in both agency-backed and private-label MBS to meet specific return targets or diversify their asset mix. The participation of these private entities adds depth and breadth to the secondary market, ensuring a wide array of investment opportunities.