Mortgage Markets Explained: Primary vs. Secondary

Mar 21, 2022
5 min.

According to Statista, the United States is home to a massive mortgage market, valued at $11.9 trillion in 2021. 

This financial sector is divided into two separate markets. These are known as the primary mortgage and the secondary mortgage markets.  

Different mortgage markets serve a particular need for homebuyers and investors who put money into the mortgage market.

  • The primary mortgage market: This market serves the home-buying public and links borrowers with mortgage lenders.
  • The secondary mortgage market: The secondary market exists for investors who invest in existing mortgages seeking returns on that investment.

This article will take a deeper dive into the primary and secondary mortgage markets, comparing and contrasting the two.

What is the primary mortgage market?

The primary mortgage market is the loan market, where homebuyers obtain their mortgage and borrow directly from lenders.

The National Association of REALTORs® has reported that nearly 75% of all home buyers financed their home purchase in 2021. This financing generally came from mortgages obtained through the primary market.

Homebuyers and those looking to refinance can obtain direct mortgage loans through various sources that make up the primary mortgage market, including:

  • Banks or credit unions: Credit unions and banks are the most common primary lenders and the source of most primary mortgage loans issued in the United States.
  • Mortgage brokers: A mortgage broker is not a lender. However, the mortgage broker’s job is to find quality primary lending sources on behalf of customers looking to buy or refinance. Mortgage brokers have direct access to lenders in the primary mortgage market. They can be incredibly beneficial to borrowers looking for the right mortgage based on their credit history and desired loan terms.
  • Online lending tools: Numerous online financial institutions offer borrowers the opportunity to secure home loans, often with lower fees and interest rates than more traditional lending institutions. However, not all online lenders are more affordable. Therefore, it is important for homebuyers to way all of their available options and consider various lending options.

What is the secondary mortgage market?

The secondary market allows investors to buy into existing mortgage loans to turn a profit.

Selling a mortgage is commonplace for most banks and primary lending institutions. It is a way to regain capital and continuously offer loans to borrowers. 

As a result, several organizations operate in the secondary mortgage market by purchasing existing loans from primary lenders and reselling them to mortgage investors. 

They include:

  • The Federal National Mortgage Association (FNMA): One of the largest secondary loan providers is the FNMA, also known as Fannie Mae. Although Fannie Mae is supervised and backed by the United States government, it is a for-profit organization, making it unique in the secondary loan market. Fannie Mae purchases loans from a variety of lenders
  • The Government National Mortgage Association (GNMA): GNMA, also known commonly as Ginnie Mae, is a government-owned, government-operated organization that purchases loans from the U.S. Veterans Administration (VA), the Federal Housing Administration (FHA), and other government lenders.
  • The Federal Home Loan Corporation: The Federal Home Loan Corporation, known more commonly as Freddie Mac, is similar to Fannie Mae. It is a private company operating within the secondary loan marketplace. It purchases most of its loan notes from savings and loans institutions.

How does mortgage investing work?

The mortgage investors ultimately keep the market going as they provide funds and the lenders’ guidelines. 

This constant financial flow keeps the market afloat by ensuring that lenders have enough money for borrowers and allowing more home buyers to secure loans.  

When a borrower obtains a mortgage, they primarily work with a lender. First, they apply for the loan, and once approved, they receive the money needed to purchase or refinance. 

Then, the borrower pays back the loan and interest until the debt is paid overtime.

If lenders were to rely exclusively on the monthly mortgage payments, they would not have enough money to offer other potential borrowers. 

That’s where mortgage investors come in. Lenders sell mortgage loans to investors through the secondary market, allowing them to secure the funds necessary to issue more loans.

As borrowers pay off these mortgages, payments are distributed to private investors that bought mortgage-backed securities on the secondary market.

How are mortgage rates determined?

Various factors determine mortgage rates. Some factors are within a borrower’s control, and some are not.

Factors within a borrower’s control

Lenders will adjust their mortgage rates based on loan risk. The riskier a loan is, the higher the interest rate. 

In determining risk, a lender will consider the likelihood of the buyer’s failure to repay the loan and how much the lender stands to lose should the borrower default.

There are two significant factors in this consideration, including:

  • Credit score: Borrowers with a credit score of 740 or better will receive the lowest interest rates and have access to a broader choice of mortgage products.  
  • The loan-to-value ratio: The larger the down payment, the lower the loan-to-value ratio. Loan-to-value ratios over 80% are considered too high and put lenders at much greater risk, resulting in much higher mortgage rates.

Factors outside of a borrower’s control

Market forces ultimately set the overall mortgage rates. Rates increase and decrease daily, based on economic indicators such as inflation, unemployment rates, job growth, and the economy’s overall strength.

The Federal Reserve also plays an essential role in mortgage rates. While the Fed does not set mortgage rates, they set short-term interest rates based on economic forces. 

Because mortgage rates fluctuate based on these same forces, Fed rates and mortgage rates typically move in tandem.

Final thoughts on mortgage markets

The way that the primary and secondary mortgage markets work together is necessary for borrowers to continue accessing the funds needed to purchase or refinance a home. 

The relationship between the two markets is symbiotic.

Primary mortgage markets give borrowers access to the funds needed to purchase a home. 

The secondary mortgage market replenishes those funds by allowing lenders to sell those mortgages to Ginnie Mae, Fannie Mac, Freddie Mae, and other private investors.

It’s a win-win situation for everyone involved, and it is the engine that keeps the housing market alive.

TL;DR: The primary mortgage market is used for homebuyers and lenders. Lenders finance a borrower's purchase of a home. The secondary mortgage market is between lenders and mortgage investors. Lenders will sell the debt to the investor who will buy it to make a profit.

Mar 21, 2022
5 min.