What is a Market-Backed Mortgage Loan?
For the average homebuyer, the mortgage business is fairly straightforward. Take out a loan, purchase your dream home, and slowly pay off the debt. But while that is the reality for many Americans, the market supporting this process is a complex machine vital to the country’s economic health. Consider this your crash course in the life of a mortgage beyond the lender-borrower relationship.
The Primary and Secondary Mortgage Markets
The mortgage market operates in two parts. The more familiar section for most people is the primary mortgage market. This is where lenders originate loans and borrowers take them out. Post-origination activities, however, take place on the secondary mortgage market.
The secondary market is where lenders sell existing mortgages to other institutions. Why? Outside organizations can package the loans in bundles called mortgage-backed securities (MSBs). These become investment opportunities for businesses and individuals across the nation. Investors buy the MSBs, essentially financing mortgages in exchange for the interest paid on them.
The primary and secondary markets are co-dependent. When loan originators sell mortgages, they receive the funds necessary for further mortgage creation. For homebuyers, this means an increased likelihood of approval. And, of course, these investors would have nothing to invest in without mortgage lenders existing in the first place.
The Ins and Outs of Mortgage-Backed Securities (MSBs)
MSBs are the diverse, intricate pillars of the secondary mortgage market. They proliferated in the 1970s in response to the housing shortage, which was brought about by the one-two punch of Baby Boomers coming of age and rising inflation. MSBs gave regional banks a way to provide more loans without running out of money. This radically changed the landscape of the mortgage business. It is now a national network operating across a variety of specialized financial institutions.
How do MSBs work? A mortgage-purchasing group puts similar loans together based on factors like interest rate and maturity. The resulting MSBs are assigned scores by a credit rating agency, which looks at borrowers’ abilities to repay loans. This process is called securitization, and it is central to the creation of a varied set of investment options.
The most common securitizers are the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, though private institutions (e.g. investment banks) participate too. The benefit of the GSE securitization process is the guarantee made by the government that investors will receive payments.
The main function of a mortgage is to provide homebuyers with a way to cover the substantial cost of housing, but its significance within our market goes much further. Just as important to investors as they are to homeowners, mortgages symbolize a path to stable investments that allow our economy to thrive.
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