Secondary Market

Once a loan is originated on the primary market, it may be sold on the secondary market. The secondary market is where lenders and investors buy and sell existing mortgages or mortgage-backed securities, thereby providing greater availability of funds for additional mortgage lending. The secondary market is the resale marketplace of loans.

If you understand the history of the secondary market, it will you help you understand what it is and why it exists.

Prior to the stock crash of 1929, most lenders required a borrower to have down payment of 20 to 40 percent. If that was the case today, not many people would be able to afford a home. You would have to be very very rich in order to get a loan, and you would have to have a lot of money to get money. Talk about the rich getting richer!

Not only did lenders require a large downpayment, but the loan was a straight mortgage, which meant they would only pay the interest. The term was typically 1 to 7 years, and at the end of the 7 years, if the borrower could not pay the entire balance, a new loan would be negotiated.

After the stock crash, the government needed to stabilize the economy and stimulate the stock market. In 1934, the government introduced FHA-insured loans. The FHA's primary purpose is to insure lenders from loss.

The FHA made it possible for a greater amount of people to purchase a home. They did this by requiring a smaller down payment and a smaller monthly payment that would extend the loan over the course of 30 years. A portion of the payment would be applied to the principal, and the remaining would be interest. This is more what you're used to seeing today.

A 30-year fixed-rate mortgage with monthly payments was a new concept at the time. There was much more risk involved with this than there was lending to a wealthy person with many assets. To reduce the risk to the lender, the FHA required the lender to verify the borrower's employment, have the property appraised by a neutral third party, and have a title search. If the government guidelines were met, then the lender would negotiate the loan.

The lenders and the government knew that with a 30-year loan there is a greater chance of default, so the government insured the loan. The borrower was a charged a one-time up-front insurance premium based on the loan amount, and one-half percent annually on the loan balance. If the borrower defaulted on the loan and the loan amount exceeded the price of the property, the FHA would pay the difference.

Great, right? Not so fast.

By 1938, the lenders who offered the FHA-insured loan had a problem. These banks were used to doing loans and getting money back very quickly, thus having the money to lend out to a new borrower. But now with smaller down payments and waiting 30 years to recover the debt, there was not as much money on hand to lend out to a new borrower.

So in 1938, the government created the Federal National Mortgage Association, or Fannie Mae. This was created to buy FHA-insured mortgages from lenders. This created the secondary marketplace and would provide lenders with the money to lend out to new borrowers.

As Fannie Mae started purchasing loans from lenders, the loans had to meet Fannie Mae guidelines. Today Fannie Mae is a quasi-government agency that is privately owned, and Fannie Mae stock may be purchased on the New York Stock Exchange. Fannie Mae buys mortgages on the secondary market, pools them together, and then sells them back as mortgage securities to investors on the open market. Monthly principal and interest payments are guaranteed by Fannie Mae, but not by the US government.

In 1968, Fannie Mae was split, and the Government National Mortgage Association, or Ginnie Mae, was created. Ginnie Mae is a federally-owned corporation of the Department of Housing and Urban Development. Ginnie Mae administers special assistance programs. The main focus of Ginnie Mae is to insure liquidity for US government-insured mortgages, including those insured by the FHA and VA.