Two types of mortgage markets exist in which transactions take place, the primary mortgage market and the secondary mortgage market. The primary mortgage market is the place where lender and borrower initiate the mortgage contract so that a person is able to purchase a home. Most buyers are not aware that in the secondary market a third party purchases their loans and packages them into securities to provide the primary institutions with an influx of capital for further lending.
Primary Mortgage Market
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The primary mortgage market is a place where the lending institution directly loans money to the borrower, or the person seeking to purchase a house or property. The lender is responsible for drafting the contract and creating the terms of the loan. The borrower agrees to the terms and the payments as stipulated by the primary mortgage institution, or shops around for another lender.
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Primary Mortgage Institutions
A primary mortgage institution is usually a bank, either commercial or a savings and loan. It may be local, privately owned, state-owned or a corporation. It does not matter if the bank is one out of many in a chain or a small family operation with just one branch. The primary mortgage institution is the direct lender of the money that the potential homeowner uses to purchase a house or other property, paying the mortgage back in monthly payments to the issuing institution.
Profits of Primary Mortgage Institutions
Primary mortgage institutions make a large portion of the institution's profits by charging interest on the money loaned to property purchasers. However, a limit exists to the amount of capital in the bank's reserve. To grant more loans, the bank needs to maintain money in this reserve. Therefore, to increase profits, it needs to obtain more capital.
Selling Mortgages of a Primary Institution
To be able to gain better profit, a primary mortgage institution will sell the loans to a business operating in the secondary market. These companies bundle the mortgages and offer them as securities called asset-backed securities or collateralized mortgage obligations in the stock market. This provides an influx of capital to the primary lender so that the lender can initiate more mortgage loans. The borrower continues to make payments to the primary institution, which funnels the money to the secondary institution. Freddie Mac is an example of such a secondary institution.