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.
The primary market consists of the actual lenders and borrowers. It is the bank or lending institution that draws up the contract and terms of the agreement, working out the details with the home purchaser. These organizations decide the amount of principal that will be lent, the interest rate to charge, and how long the loan will be for.
The repetition of this process for individuals and businesses begins to slowly deplete the resources of the bank. Loans can be made for home purchases, or other personal or commercial reasons. As more people are lent money, the reserves of the institution are slowly no longer available for others to use.
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.
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.
The borrower need not be worried about the possibility of losing their home because of this process. The mortgage loans are not at risk. However, the investor should worry if a significant amount of people default on their loans. The process involving the secondary market can be very difficult to comprehend.
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