The Flow of Mortgage Funds – Your Local Bank to Mortgage Backed Securities
The availability of funds in the primary market largely depends on the existence of the secondary markets. First, home buyer mortgage money is loaned by the lending institution in the primary market. The mortgage is then sold to a secondary market agency, which may in turn sell it to other investors in the form of mortgage-backed securities. Mortgage-backed securities are divided into two general types: bond-type securities and pass-through securities. The securities are of the long-term bond type, pay interest semi-annually, and provide for repayment on a fixed date. Scroll through the most popular securities, and pay interest and principal payments on a monthly basis. Some types of securities pass are paid even if the payment has not been collected from the borrower.
Since the primary lender sold the mortgage, the lender can take the money it receives from the sale and make another mortgage, then sell that new loan to the secondary market, continuing in the cycle. A secondary market agency can pool the mortgages it buys to create mortgage-backed securities, which it then sells to investors. Because the secondary market agency sells mortgage-backed securities to investors, it now has more money to buy more mortgages. He can then create more mortgage-backed security pools to sell back to investors, and the cycle continues.
The market is able to function as is because uniform underwriting criteria are used to qualify borrowers and properties. The mortgage will only be purchased by the secondary market if the primary market lender complies with the underwriting criteria of the secondary market. Since lenders want to sell their loans, they must follow those agencies’ underwriting standards. The three largest secondary market agencies are Fannie Mae, Freddie Mac, and Jeannie Mae. So, a matching loan is typically a loan that meets Fannie Mae’s underwriting guidelines. Private companies such as hedge funds and investment banks also participate in the mortgage money flow by purchasing mortgage-backed securities. The recent credit crash and economic recession was due in part to the buying and selling of mortgage-backed securities. Investors borrowed incredible amounts of money and cashed themselves in so much that when the value of mortgage-backed securities fell, it was enough to create massive liquidity problems for companies and many of them went out of business (Bear Stearns, Merrill Lynch, etc). Unfortunately, many of the same dynamics that caused the financial crash are still at work today. The secondary market still exists as Fannie Mae (full of taxpayer money) now buys up to 99% of all loans originating in the US.
