The Secondary Mortgage Market

The secondary mortgage market is where existing mortgages are bought and sold. Lenders originating residential mortgage loans traditionally replenished their capital by selling the loans to the U.S. and foreign banks, to investors willing to hold mortgage loans on a long-term basis, or to Fannie Mae or Freddie Mac. More recently, the secondary mortgage market expanded to include investment banks and international investors who purchased interests in residential mortgage loans in the form of mortgage-backed securities.

Wall Street Investment Bankers packaged residential mortgage loans in securitized pools in the form of mortgage-backed securities for sale to foreign and domestic investors by broker-dealers. Private companies underwrote these mortgage-backed securities, which were then rated by recognized bond rating firms, i.e., Moody's, Standard & Poor's, and Fitch.

This expanded secondary mortgage market included participants buying and selling amongst themselves. The Wall Street expansion of the secondary mortgage market was established to facilitate the sale of alternative mortgages or non-traditional loan products that would not have been saleable in the historic secondary market.

Federal National Mortgage Association (FNMA or Fannie Mae)

Fannie Mae initially provided a secondary market for FHA and VA-insured or indemnified loans and, since the early 1970s, conventional mortgages originated by approved lenders (sellers/servicers). Initially, FNMA required that conventional loans were to be insured by a private mortgage insurer to be acceptable for purchase.

Fannie Mae's sources of funds include borrowing; selling long-term notes, mortgage-backed securities (MBS), and debentures in the capital markets; issuing and selling its own common stock; and earning from its mortgage portfolio, including various fees imposed upon seller/servicers.

Fannie Mae purchased graduated payment mortgages (GPMs), conventional fixed-rate first and qualifying second mortgages, and a variety of ARMs, each secured by 1 to 4-family dwellings. Fannie Mae continues to maintain a resale/refinance program whereby approved lenders (sellers/servicers) offer borrowers the opportunity to convert ARMs to fixed interest rate loans or to obtain new mortgage loans at competitive interest rates.

Since the early 2000s, Fannie Mae expanded its acceptable loan products to include many of the nontraditional or alternative mortgage loan products being originated by their approved lenders (seller/servicers). FNMA's mortgage-backed securities (MBS) plan included non-traditional or alternative mortgage products.

The MBS plan involved approved lenders selling blocks or pools of mortgages in exchange for a like number of securities that represented undivided interests or participation in a designated pool of loans that may be sold to or retained by qualifying lenders. FNMA provides a 100% guarantee of full and timely payment of interest and principal to the holders of the securities.

While Fannie Mae is the largest investor in the secondary residential mortgage market, it delegates most underwriting and servicing responsibilities to approved lenders (sellers/servicers) in accordance with Fannie Mae's guidelines. FNMA has also played a major role in the development of standardized loan origination documents, including the 1003 loan application form, promissory notes and deeds of trust (with various addendums depending on the residential mortgage loan product), and uniform residential appraisal reports (Fannie Mae guide forms). These guide forms are also approved by the Federal Home loan Mortgage Corporation (FHLMC-Freddie Mac).

Fannie Mae has a 15-member board of directors, 10 elected by shareholders, and 5 appointed by the President of the United States. Until recently Fannie Mae was a government enterprise primarily controlled by its shareholders who were largely approved lenders (seller/servicers). As of this writing, Fannie Mae has been placed into conservatorship by the federal government to continue its operations through a series of financial "bailouts" as authorized by the U. S. Congress.

Government National Mortgage Association (GNMA or Ginnie Mae)

Ginnie Mae is a government corporation that administers mortgage support programs that could not be carried out in the private marketplace. Ginnie Mae increases liquidity in the secondary mortgage market and attracts new sources of funds for residential loans. Ginnie Mae does not purchase mortgages. Rather, it adds its guarantee to mortgage-backed securities (MBS) issued by approved lenders (sellers/servicers). 

GNMA's three major activities include:

1. Mortgage-backed securities (MBS) Program.

2. Special assistance functions; and

3. Management and liquidation function

Through the MBS Program, Ginnie Mae guarantees securities issued by financial intermediaries that are backed by pools of mortgages. Mortgage bankers, savings institutions, commercial banks, and other approved types of financial intermediaries are issuers of securities. Holders of these securities receive a pass-through of principal and interest payments on the pool of mortgages, fewer amounts to cover servicing costs and certain Ginnie Mae fees. Ginnie Mae guarantees that the holders of the securities will receive payments of principal and interest as scheduled, as well as unscheduled recoveries of principal due to prepayments. Because of the federal guaranty (pledge of full faith and credit of the U.S. Government), Ginnie Mae mortgage-backed securities are considered by many to be as safe, as liquid, and as easy to hold as securities issued directly by the U. S. Treasury.

The MBS programs of FNMA and GNMA have benefited all regions of the country by increasing the flow of capital/funds from the securities market to the residential mortgage loan market and from capital surplus to capital-short geographical areas. Under the special assistance functions, GNMA purchases certain types of mortgages to provide support for low-income housing and to counter declines in mortgage lending and in housing construction. Under the management and liquidation functions, GNMA manages and liquidates (sells) portfolios of federally-owned mortgages. The President of the United States appoints the President of GNMA, who acts under the direction of the Secretary of the Department of Housing and Urban Development (HUD).

Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)

Freddie Mac was established to increase the availability of mortgage credit for the financing of urgently needed housing by developing, expanding and maintaining a nationwide secondary market primarily for conventional loans originated by savings and loans, savings banks, thrift institutions, commercial banks, mortgage bankers and other HUD-approved lenders/mortgagees. Freddie Mac finances most of its mortgage purchases through the sale of mortgage participation certificates (PCs) that require issuance and acquisition by qualified investment buyers (QIBs).

Through its standard programs, Freddie Mac buys:

• Whole loans and participation interests in conventional 1 to 4 family dwelling loans with both fixed and adjustable rates;

• Home improvement loans; and,

• Multifamily whole loans and participation interests therein.

The mortgages purchased in the standard programs are generally less than one year old. Freddie Mac underwrites the loans delivered under its purchase commitments and rejects loans that do not meet its underwriting guidelines. Residential mortgage loans secured by 1 to 4 dwelling units with loan-to-value ratios above 80 per cent must carry private mortgage insurance coverage.

Freddie Mac's guarantor or "Swap" program gives primary mortgage lenders an added source of liquidity during periods when the yield on mortgage portfolios of predominantly older loans is lower than the lenders' cost of funds. Lenders may thus convert a low yield portfolio into highly liquid securities that can be sold or used as collateral for the lenders' borrowing of funds. Until recently, Freddie Mac was an independent stock company and functions in direct competition with Fannie Mae. Freddie Mac has an 18-member board of directors, 13 are elected by Freddie Mac's stockholders, and 5 are appointed by the President of the United States. As of this writing, Freddie Mac was placed into conservatorship by the United States government to facilitate "bailouts" as authorized by Congress to be able to continue its residential mortgage loan programs.

Key points to remember:

• The secondary mortgage market is where existing mortgages are bought and sold.

• Investors, such as Fannie Mae, Freddie Mac, and investment banks, are active participants in the secondary market.

• Mortgage-backed securities (MBS) are bundles of mortgage loans that are sold to investors.

• A healthy secondary mortgage market is essential for a strong housing market.