welcome to pmiâ€™s on demand training bootcamp

Welcome to PMI’s On Demand Training Bootcamp

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PMI MORTGAGE INSURANCE CO.

Overview of the Secondary Market

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Introduction to Mortgage Lending Course Overview

Mortgage Lending BasicsOrigination Process


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Overview of the Secondary Market - Agenda

OverviewPrimary vs. Secondary MarketsBenefits of the Secondary MarketHow the Secondary Market WorksParticipants in the Secondary MarketMI Companies’ Role in the Secondary market

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Overview of the Secondary MarketPrimary vs. Secondary Markets

In the real estate industry, the primary market is comprised of lenders (mortgage companies) and borrowers (consumers). This is where a loan originates.

The secondary market consists of lenders and a large diverse group of investors. The investors buy and sell home mortgage loans that have already closed from lenders across the country.

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Overview of the Secondary MarketBenefits of the Secondary Market

Why does the secondary market exist? Consider a lender with $10 million in deposits to make loans. After making just 50 loans of $200,000, this lender will have run out of funds. The lender would have to wait for years until the loans are repaid before making any more loans. This is exactly what used to happen before the rise of the secondary market.

By selling their loans to investors, lenders get their money back immediately and are free to make more loans. And the investors get a place to park their money and receive a better rate of return than they might get elsewhere.

Did You Know?The secondary market does not affect the borrower. He or she makes the same payments whether the loan is sold in the secondary market or not. The only thing that might change is the address where borrowers send their monthly payment.

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Besides replenishing their loan funds, there are two other reasons why lenders like to sell their loans to the secondary market: less risk and greater profit potential. A mortgage lender faces two types of risk: credit risk and interest rate risk.

Credit risk is the risk that the borrower won’t pay back the loan, potentially creating a loss for the lender.

Interest rate risk is the risk that the cost of funding loans over time may become greater than the interest rate the lender earns on the loans.

When a lender sells a loan to an investor, the investor assumes these risks.

How does an interest differential protect a

lender from interest rate risk?

Suppose a local savings bank makes 30-year fixed-rate loans at 7%. Let’s also suppose this bank pays depositors 4%. This bank has a 3% interest differential between money it takes in and money it lends out. That’s probably enough to cover overhead and make a fair profit. But if interest rates rise and the bank had to start paying 6% on deposits to attract customers, the interest differential would shrink to 1%. After expenses, this would be insufficient for the bank to make a profit. Most experts agree that an interest differential of 2.5% to 3% is required for this purpose.

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Mortgage lenders sell their loans to the secondary market so they can turn around and make new loans. Lenders charge a fee to cover the administrative costs of processing, approving, and making a mortgage loan. The more loans they make, the more opportunities they have to collect these loan fees and increase their profits.

One of the basic administrative fees is the loan origination fee, which is often expressed in points. One point equals 1% of the mortgage amount. For example, a $200,000 mortgage with a loan origination fee of one point would mean the borrower pays the lender a $2,000 fee.

Did You Know?Besides loan origination fees, other common fees charged by lenders include an underwriting fee, appraisal fee, credit report fee, and document preparation fee.

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Overview of the Secondary Market - Self CheckBenefits of the Secondary Market

The two types of risk that a mortgage lender faces are credit risk and interest rate risk.

TrueFalse

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Overview of the Secondary Market - Self CheckBenefits of the Secondary Market

Mark is applying for a $200,000 loan. The loan origination fee is 2 points. What is the cost of Mark’s loan origination fee?

$1,000$2,000$3,000$4,000

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Overview of the Secondary MarketHow the Secondary Market Works

The investors who buy loans in the secondary market never meet the borrowers or see the properties (their collateral). So what gives them confidence that the loans are high quality? Despite the current credit market, mortgage loans are historically quite safe. Most consumers give their house payment top priority since they don’t want to risk losing their house and any equity they’ve built up.

Second, the industry has a standardized set of loan documentation and underwriting guidelines that are designed to weed out bad loans before they are written.

And third, many loans are insured or guaranteed by government-sponsored enterprises.

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What happens if a lender makes a loan at 7%, but before the lender can sell it, the interest rate in the secondary market jumps to 8%? No investor would want to buy this loan because it pays a lower rate than they can get elsewhere. The lender could sell the loan at a discount below its face value, but this would mean a loss to the lender. To prevent situations like this, lenders can buy forward commitments in the secondary market.

A forward commitment allows the lender to sell a certain amount of loans at a specified interest rate for the next 60 days. The lender can sell them at their full value even if the interest rates are higher by the time the sale occurs.

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So far we’ve talked about selling a loan as if it were a single asset. Actually, a loan produces two assets: the loan itself and the rights to service that loan. Both of these can be sold.

When a lender keeps the servicing rights, it’s called “servicing retained.”

When a lender sells the servicing rights, it’s called “servicing released.”

What does “servicing”a mortgage loan mean?Servicing a mortgage means collecting the monthly payments from the borrower, making sure taxes and insurance get paid, and handling foreclosure on the house if that becomes necessary. Many mortgage bankers service the loans they sell, while other lenders usually contract these services. The two main goals of loan servicing are to protect the asset and to generate profit.

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Overview of the Secondary Market - Self CheckHow the Secondary Market Works

A forward commitment allows a lender to sell their loans at their full value even if the interest rates are higher by the time the sale occurs?

TrueFalse

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Overview of the Secondary MarketParticipants in the Secondary Market

The engine behind the secondary market is the network of government-sponsored enterprises (GSEs) and capital market participants other than GSEs that buy mortgages, bundle them together, and resell them to investors as a mortgage-backed security.

The GSEs are the same ones discussed in the Mortgage Lending module:

Fannie MaeFreddie MacGinnie Mae

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Overview of the Secondary MarketParticipants in the Secondary Market

In a nutshell, here are some of their similarities and differences.

Fannie Mae buys loans for both its own portfolio and for resale,whereas all the loans Freddie Mac buys are resold. Ginnie Mae only provides guarantees; it does not buy mortgages.

Fannie Mae and Freddie Mac deal mainly in conventional mortgages (those not guaranteed by the government), while Ginnie Mae deals in government loans (FHA, VA and Farmers Home).

Both Fannie Mae and Freddie Mac use the same loan forms and set limits on the size of the loans they will buy or guarantee. The Fannie Mae and Freddie Mac limits are called conforming loan limits. Loans for amounts higher than this are called jumbo loans.

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Overview of the Secondary Market - Self CheckParticipants in the Secondary Market

The engine behind the secondary markets are the government-sponsored enterprises (GSEs), which include all but one of the following:

FHAFreddie MacFannie MaeGinnie Mae

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Fannie Mae and Freddie Mac set jumbo loan limits?TrueFalse

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Overview of the Secondary MarketMI Companies’ Role in the Secondary Market

If the government guarantees government loans, who guarantees conventional loans? This is a service provided by private mortgage insurance (MI) companies.

MI protects a lender if a borrower defaults. MI is usually required on conventional loans with down payments of less than 20% and occasionally on loans that do not completely meet applicable underwriting criteria. The cost of this coverage is generally paid by the borrower along with his or her monthly mortgage payment.

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Overview of the Secondary MarketMI Companies’ Role in the Secondary Market

In order for a GSE to buy a mortgage, the loan must meet the GSE’s quality requirements. To ensure quality, GSEs require MI on loans with an LTV ratio higher than 80%. Without MI, mortgage investors would have greater exposure to catastrophic losses.

MI companies also write pool insurance on bundles of mortgage loans for the GSEs, which then package mortgages into mortgage-backed securities.

What is the secondary market?

The secondary mortgage market is a major source of housing credit in the United States. Mortgage loans originate in the primary market, where homebuyers obtain loans from their individual banks, credit unions, or other lenders. Entities in the secondary market buy existing mortgages that meet their criteria. This allows funds to be replenished so lenders can make more loans.

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Private Mortgage Insurance (MI) companies insure lenders when a borrower defaults?

TrueFalse

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Bottom LineThe secondary market is a massive network of lenders, GSEs, and investors that buy and sell mortgages and mortgage-backed securities for investment purposes –a process that ensures an ongoing supply of funds for borrowers’ mortgage needs.

Three GSEs (Fannie Mae, Freddie Mac, and Ginnie Mae) are the driving force of the secondary market.

Private mortgage insurance protects the lender if the borrower defaults and enables homebuyers with down payments of less than 20% to purchase homes.

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