Primary and Secondary Mortgage Markets

The key economic function of a mortgage lender is to provide funds for the purchase or refinancing of residential properties. This function takes place in the primary mortgage market where mortgage lenders originate mortgages by lending funds directly to homeowners. This market contrasts with the secondary mortgage market. In the secondary mortgage market, lenders and investors buy and sell loans that were originated directly by lenders in the primary
mortgage market. Lenders and investors also sell and purchase securities in the secondary market that are collateralized by groups of pooled mortgage loans.

Banks that use the secondary market to sell loans they originate do so to gain flexibility in managing their long-term interest rate exposures. They also use it to increase their liquidity and expand their opportunities to earn fee-generated income.

The secondary mortgage market came about largely because of various public policy measures and programs aimed at promoting more widespread home ownership. Those efforts go as far back as the 1930s. Several government-run and government-sponsored programs have played an important part in fostering home ownership, and are still important in the market today. The Federal Housing Administration (FHA), for example, encourages private mortgage lending by
providing insurance against default. The Federal National Mortgage Association (FNMA or Fannie Mae) supports conventional, FHA and Veteran’s Administration (VA) mortgages by operating programs to purchase loans and turn them into securities to sell to investors.

Most of the loans mortgage banks sell are originated under government-sponsored programs. These loans can be sold directly or converted into securities collateralized by mortgages. Mortgage banks also sell mortgages and mortgage-backed securities to private investors. Mortgage-backed securities, in particular, have attracted more investors into the market by providing a better blend of risk profiles than individual loans.