When purchasing a home, many people either do not have the cash on hand or wish to spread the total payment over a long period of time, such as 15 to 30 years. Mortgage loans are available to allow people to finance the majority of the housing purchase. However, once the contract is signed, most banks actually sell these loans to another banking institution which operates in the secondary mortgage 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.
For a bank, this is a repetitive procedure that is completed for numerous amounts of people or businesses. A loan does not have to be for a housing purchase, but can be made for several different reasons. Doing such slowly eliminates the reserve funds that they have on hand. Over time they can become depleted.
Since one of the main sources of income in institutions such as these comes from the interest paid, they are going to want to get more money to lend out. For this reason, they often sell a bundle of the home loans to businesses that operate in the secondary market. These companies buy mortgages from the banks that operate in the primary market.
After purchasing the home loans, the company will often bundle them together with other similar purchases in an effort to sell them as a security on the stock market. These securities are referred to as mortgage-backed securities or collateralized debt obligations (CDO), amongst other names. Individuals can then purchase shares in these funds, which enables the business to hopefully cover the risk of default and possibly make a profit.
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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