Have you ever asked yourself the above question? Where does the money come from that is so readily available for home loans? I remember the time when I was shopping for my first home loan in 1970. We had a substantial downpayment and still could not find a bank or savings and loan that would finance my purchase. We had good jobs and good credit, yet there was a crunch for loan funds so purchase money was not readily available. Without even knowing the term "creative financing" or "seller carryback," we asked the seller to finance our purchase of his home. Fortunately for us, he did. Much has changed in the lending industry in the last twenty seven years.
Today, two out of three mortgages are sold on the secondary market. The secondary market is a massive financial network. Various components of this network purchase and/or insure loans generated by lenders across the country. These loans are then converted into securities, i.e., investments collateralized by mortgages that are sold to investors. When you think of the secondary market, picture the workings of the New York or American stock exchanges---where corporate securities are bought and sold.
As you know, an investor buys stock or bonds in a company allowing that company to expand and grow. The investor also has the potential to earn income on the stock or bond purchased relative to the performance of the company.
Lenders, as corporations, sell mortgages to maintain an adequate supply of mortgage funds. With the selling of mortgages, new funds are then received by the lender so that there is an ongoing supply of money for future loan financing. In the same way that stockholders expect a return on their investment, secondary market players receive profits from their involvement. The individuals and companies that buy securities receive monthly earnings.
The monthly income comes from an ownership interest in a pool of home loans. As monthly payments are made by the borrower, a proportionate share of the principal and interest is returned to each investor. So, if you own shares in FannieMae, Freddie Mac and/or Ginnie Mae you are participating in the secondary market. Some insurance companies and pension funds also purchase loans. However they, along with Wall Street investors and institutional investors (mutual fund companies), serve as the main investors in mortgage securities sold by FannieMae, Freddie Mac and Ginnie Mae.
The secondary market (the purchaser of the loans/investor) sets the guidelines that must be followed by the lender. There are guidelines set by FannieMae and Freddie Mac requiring specific downpayment criteria, loan amounts, debt/income ratio maximums, credit rating and type of property to be financed. Typically the above investors will lend on single family residences and two to four unit investment properties. If the loan is not for a primary residence, the investor will require a higher downpayment to offset the risk involved with investment property. Remember there are shareholders' dollars at stake and the bottom line is of concern.
Ginnie Mae is the entity that handles government loans, such as FHA and VA. They will have different underwriting guidelines as to loan limits, downpayment, debt to income ratio and credit requirements. Outside the above conforming criteria, secondary market investors exist that will set their own underwriting criteria and are called non-conforming purchasers and/or portfolio lenders. As you can see, we have a circular structure from lender to investor to the public affording us the opportunity to finance an almost unlimited number of loans for the American home buyer.
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