A mortgage can be seen as a stream of future cash flows. These cash flows are bought, sold, stripped, tranched and securitized in the secondary mortgage market. The secondary mortgage market is extremely large and very liquid. Most mortgages are sold into the secondary mortgage market.

In this article, we'll show you how the secondary mortgage market works and introduce you to its major participants. Secondary Mortgage Market Participants There are four main participants in this market: The Mortgage Originator The mortgage originator is the first company involved in the secondary mortgage market.

Mortgage originators consist of banks, mortgage bankers and mortgage brokers. One distinction to note is that banks and mortgage bankers use their own funds to close mortgages and mortgage brokers do not. Mortgage brokers act as independent agents for banks or mortgage bankers. While banks use their traditional sources of funding to close loans, mortgage bankers typically use what is known as a warehouse line of credit to fund loans.

Most banks, and nearly all mortgage bankers, quickly sell newly originated mortgages into the secondary market. However, depending on the size and sophistication of the originator, it might aggregate mortgages for a certain period of time before selling the whole package - it might also sell individual loans as they are originated. There is risk involved for an originator when it holds onto a mortgage after an interest rate has been quoted and locked in by a borrower.

If the mortgage is not simultaneously sold into the secondary market at the time the borrower locks the interest rate, interest rates could change, which changes the value of the mortgage in the secondary market and, ultimately, the profit the originator makes on the mortgage.

Originators that aggregate mortgages before selling them should hedge their mortgage pipelines against interest rate shifts. There is a special type of transaction called a best efforts trade, designed for the sale of a single mortgage, which eliminates the need for the originator to hedge a mortgage.

Smaller originators tend to use best efforts trades. To learn more, see A Beginner's Guide To Hedging.

In general, mortgage originators make money through the fees that are charged to originate a mortgage and the difference between the interest rate given to a borrower and the premium a secondary market will pay for that interest rate.

The Aggregator Aggregators are the next company in the line of secondary mortgage market participants. Aggregators are large mortgage originators with ties to Wall Street firms and government-sponsored enterprises GSEs , like Fannie Mae and Freddie Mac.

Aggregators purchase newly originated mortgages from smaller originators, and along with their own originations, form pools of mortgages that they either securitize into private label mortgage-backed securities by working with Wall Street firms or form agency MBSs by working through GSEs. To learn more about GSEs, see Profit From Mortgage Debt With MBS.

Similar to originators, aggregators must hedge the mortgages in their pipelines from the time they commit to purchase a mortgage, through the securitization process, and until the MBS is sold to a securities dealer.

Hedging a mortgage pipeline is a complex task due to fallout and spread risk. Aggregators make profits by the difference in the price that they pay for mortgages and the price for which they can sell the MBSs backed by those mortgages, contingent upon their hedge effectiveness.

Securities Dealers After an MBS has been formed and sometimes before it is formed, depending upon the type of the MBS , it is sold to a securities dealer. Most Wall Street brokerage firms have MBS trading desks.

Dealers do all kinds of creative things with MBS and mortgage whole loans. The end goal is to sell securities to investors.

How Mortgage Companies Make Money Selling Your Mortgage

Dealers frequently use MBSs to structure CMO, ABS and CDO deals. These deals can be structured to have different and somewhat definite prepayment characteristics and enhanced credit ratings compared to the underlying MBS or whole loans.

Dealers make a spread in the price at which they buy and sell MBS, and look to make arbitrage profits in the way they structure CMO, ABS and CDO deals. Investors Investors are the end users of mortgages. Foreign governments, pension funds , insurance companies, banks, GSEs and hedge funds are all big investors in mortgages.

MBS, CMOs, ABS and CDOs offer investors a wide range of potential yields based on varying credit quality and interest rate risks. Foreign governments, pension funds, insurance companies and banks typically invest in high-credit rated mortgage products. Certain tranches of the various structured mortgage deals are sought after by these investors for their prepayment and interest rate risk profiles.

Hedge funds are typically big investors in low-credit rated mortgage products and structured mortgage products that have greater interest rate risk. Of all the mortgage investors, the GSEs have the largest portfolios. The type of mortgage product they can invest in is largely regulated by the Office of Federal Housing Enterprise Oversight. The Bottom Line In a matter of weeks, maybe a month, from the time a mortgage is originated it can become part of a CMO, ABS or CDO deal.

Few borrowers realize the extent to which their mortgage is sliced, diced and traded. The end user of a mortgage might be a hedge fund that makes directional interest rate bets or uses leveraged positions to exploit small relational pricing irregularities, or it might be the central bank of a foreign country that likes the credit rating of an agency MBS.

On the other hand, it could be an insurance company based in Brussels, that likes the duration and convexity profile of a certain tranche in an ABS, CMO or CDO deal. The secondary mortgage market is huge, liquid and complex with several institutions that all take a slice of the mortgage pie. For a one-stop shop on subprime mortgages and the subprime meltdown , check out the Subrpime Mortgages Feature.

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Sophisticated content for financial advisors around investment strategies, industry trends, and advisor education. Behind the Scenes of Your Mortgage By Barry Nielsen Updated May 25, — Mortgage Basics Secondary Mortgage Market Participants There are four main participants in this market: Understand how rate changes can affect home prices and learn how you can keep up. As home-buying technology has progressed, the process of finding the best mortgages rates can all be done online.

Applying for a mortgage can be a strenuous process. Here are five things to avoid doing when meeting with your mortgage broker. Learn how the secondary mortgage market and investor demand affect the cost of home ownership. You may be anxious to buy a home, but taking time to save a large down payment has numerous advantages.

When homebuyers educate themselves on how mortgage lenders get paid and make money, they are more likely to save thousands of dollars on their mortgages. Hidden costs can create what looks like a good deal. Find out how to find the best mortgage possible.

We explain the calculation and payment process as well as the amortization schedule of home loans. Securitization is the process of taking an illiquid asset, or group of assets, and through financial engineering, transforming Yes, if your mortgage lender goes bankrupt you do still need to pay your mortgage obligation.

Here's what usually happens An expense ratio is determined through an annual A hybrid of debt and equity financing that is typically used to finance the expansion of existing companies. A period of time in which all factors of production and costs are variable. In the long run, firms are able to adjust all A legal agreement created by the courts between two parties who did not have a previous obligation to each other.

A macroeconomic theory to explain the cause-and-effect relationship between rising wages and rising prices, or inflation. A statistical technique used to measure and quantify the level of financial risk within a firm or investment portfolio over No thanks, I prefer not making money. Content Library Articles Terms Videos Guides Slideshows FAQs Calculators Chart Advisor Stock Analysis Stock Simulator FXtrader Exam Prep Quizzer Net Worth Calculator.

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