Mortgage loans are a means to obtain money to purchase a house or real estate. Many people borrow the majority of the funds needed to buy their home, and then finance the remainder through a lending institution. By doing this, they are able to spread the payments over an allotted period of time, usually 15 to 30 years. What most people do not know is that many of their loans are then sold to another bank in the secondary market.
When a borrower is finding a bank to lend the money to purchase a house, they are searching in the primary market. This is where the lender and borrower will agree upon the terms of the contract. The decisions to be made have to do with the principal being borrowed, the interest rate charged on the loan, and the length of time for repayment.
After the money has been given to the borrower, the bank’s reserves are reduced by this amount. Over time they are reduced significantly because they are repeating this process for many people or businesses. It may not be a mortgage, but could be a commercial or personal loan, that the funds are being used for.
Institutions which function in the secondary market purchase these loans from the primary lenders. The reason that the first lender is willing to sell is because they would like to have more funds on hand to lend to other people. The interest charged on these loans is a means to produce a large portion of their income.
Once purchased, many of these companies bundle the purchases together and sell them as securities called collateralized debt obligations (CDO)or collateralized mortgage obligations (CMO), and other names. These are sold on the stock market for investors to purchase shares in. By doing this, the business hopes not only to cover the risk of default, but also profit from investors.
A home buyer need not worry about the loss of their mortgage loans or the bank’s inability to cover the payment. The secondary market bears no effect on this. What it does affect is the investor seeking to purchase shares of the securities, especially if a number of borrowers default on their payments. This is a complicated process to understand for many.
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