Why the Secondary Market Matters

The secondary market is where bonds go to be bought and resold. The ones buying and selling are large lenders such as big banks, insurance companies, the government, and other institutional investors. Mortgages are bought by these investors on the secondary market. But before they reach the secondary market, mortgages need to undergo a process called securitization.

Securitization is when a group of mortgages are bundled together into tradable units, called MBSs or mortgage-backed securities. Mortgages need to be turned into these tradable units because they’re bonds. Because bonds have many loan characteristics, they're a type of loan that can’t be as easily traded as stock units.

So why can’t big banks or the government invest in mortgages the way people do stocks? Here’s the thing, when you buy company stock, you’re buying percentage shares of a company. But mortgages are bonds. Bonds are a type of loan that act as an I.O.U. between the lender and the debt holder. They’re more complex investments because they have unique characteristics, such as how likely someone will pay back their mortgage over time.

How MBSs are Created

So once you find a whole bunch of mortgages that have similar characteristics, you securitize them or “package” them into bundles of say, a thousand mortgages. The ones responsible for securitization are Fannie Mae and Freddie Mac, two GSEs (government-sponsored entities), or Ginnie Mae, a government agency, though most loans are securitized by Fannie and Freddie. It’s the GSEs job to maintain liquidity and stability in the housing market. In fact, Fannie Mae and Freddie Mac were actually taken over by the government after the crash of ‘08 to make sure that a housing crisis like it never happened again.

So once Fannie and Freddie securitize and package these groups of mortgages, these bundles of mortgages become known as mortgage-backed securities. Mortgage-backed securities are tradable units that Fannie and Freddie or private investors can buy and resell to other investors, such as smaller banks or brokers.

One private investor, United Wholesale Mortgages (UWM), is a what’s called a wholesale lender. Rate Leaf works with UWM to get your home loan funded, but we take care of your approval and application process. As a mortgage broker, it’s also my job to find you the lowest rate that’s available to you under the present circumstances.

How MBSs are Graded

But before we really get into how the secondary market makes it possible for me to find you a low mortgage interest rate, we still need to talk about how MBSs are graded. I’d like you to understand how mortgages work front the ground up, so that you can feel confident and informed when you start the home buying process yourself.

Previously, we talked about how mortgages are turned into tradable units. Being a type of bond, you can only trade groups of mortgages that have similar characteristics. Otherwise, you wouldn’t be able to calculate whether or not you’re buying a good batch of mortgages. As they say, one bad apple can spoil the bunch, so when investing, lenders need to keep in mind the quality of the mortgages they want to invest in.

We’ve already talked about how MBSs are created. However, how they’re grouped into categories is something else entirely, and it relies heavily on your FICO score. Rating agencies will grade MBSs based on the homeowner’s potential to pay back the loan in a timely manner.

Investment grade MBSs are bundles of mortgages whose homeowners have good FICO scores and reasonable debt to income ratios, among other things. An MBS is graded as prime, as a medium risk investment or as a subprime mortgage.

The standards used to grade MBSs are set by the companies Standard & Poor’s and Moody’s.

Here’s a chart that you can use as a reference for how mortgage bonds are graded.

How the Secondary Market Lowers Mortgage Rates

Now I know that took a while, but it’s really important to me that you understand how mortgages work. Mortgages are one of the most common forms of investment. They make up about 20% of our GDP, so it’s important to know how these investments happen!

Now that you know how mortgages are traded and created, you need to understand why. Way back when, if someone wanted a mortgage, they would have to go to big banks to buy a home. These big banks had a monopoly on the mortgage industry. That was because smaller banks didn’t have the funds to be able to originate mortgage loans. Homeowners were then left at the mercy of big banks that charged them high interest rates.

But even with this unfair advantage, huge private investors didn’t want all of these loans on their balance sheets. So they started looking for ways to get rid of them by selling them to smaller banks and brokers. And that’s how the secondary market was born!

By leveling the playing field for smaller investors, a wider variety of mortgage interest rates became available to home buyers. That makes it possible for me, the mortgage broker, to bring you several rate options from different lenders. That way, you can find a low mortgage interest rate that’ll benefit you in the current market.

What’s great about working with wholesale lenders like UWM, is that they sell MBSs to brokers at a lower, discounted rate, which makes home buying more affordable for you when you team up with Rate Leaf.