Do Banks Buy Mortgages? Understanding the Secondary Mortgage Market

When you take out a mortgage from a lender like a bank, you likely assume you’ll be making payments to that same institution for the entire length of the loan.

If you’ve ever received notice that your mortgage was sold to another entity, you may have wondered why this occurs and what it means for you as the borrower.

Yes, banks do buy mortgages. This is a common practice in the secondary mortgage market where banks and other financial institutions purchase existing mortgages from lenders. The process allows banks to earn interest income, meet customer demand for home financing products, manage risk, generate capital, improve liquidity and manage growth.

However, it’s actually quite common for banks and other lenders to sell mortgages to other banks and investors. This transfer of loans between institutions is known as the secondary mortgage market. 

Read on to learn more about the secondary mortgage market, why banks buy and sell home loans, and how this process affects you.

How Do Banks Benefit from Buying Mortgages?

Financial institutions like banks have a few key incentives to purchase mortgages from other lenders:

• Earn interest income – The main way banks profit from mortgages is through collecting interest payments from borrowers over the life of the loan. Purchasing mortgages provides a source of interest revenue.
• Meet customer demand – Banks that take customer deposits need to find productive uses for that capital. Buying mortgages helps satisfy customer demand for home financing products. 
• Manage risk – Purchasing a diverse pool of mortgages spreads risk across many borrowers instead of concentrating it with just a few loans. This diversification protects the bank’s bottom line.

In short, buying mortgages generates profits, provides loans to meet customer needs, and balances risk for banks.

What Is the Secondary Mortgage Market?

The secondary mortgage market refers to the buying and selling of existing mortgages between lenders, banks, and other investors. It contrasts with the primary mortgage market, where loans are initially made to homebuying consumers.

In the secondary market, the original lender sells the mortgage and transfers servicing rights to a new institution. The borrower still makes payments to the new servicer. This market provides liquidity to lenders to make new loans and allows investors to buy mortgage products.

Major participants in the secondary market include government-sponsored enterprises like Fannie Mae and Freddie Mac, as well as private banks and lenders. Trillions of dollars in existing mortgages are traded through the secondary market each year.

Why Do Banks Sell Mortgages?

If mortgages are profitable assets for banks, why do they often sell them off? Some key reasons lenders sell mortgages include:

• Generate capital – The sale provides an immediate infusion of capital that the lender can use to issue new loans. This increases their lending capacity.
• Mitigate risk – The lender transfers the risk of default or prepayment to the purchasing entity. This removes risk from their books.
• Earn fees – Arrangement and servicing fees are earned on the sale. This provides revenue. 
• Improve liquidity – Selling the mortgage asset converts it into cash on hand, improving liquidity.
• Manage growth – Loan sales prevent a lender’s portfolio from getting too large too quickly. Steady controlled growth can be maintained.

While giving up interest income, lenders tap multiple benefits from mortgage sales.

How Does the Process of Buying and Selling Mortgages Work?

The mortgage sales process involves several steps:

• Origination – A lender like a credit union or bank funds a mortgage for a homebuyer. 
• Warehousing – The originated loans are temporarily pooled together until enough volume for a sale is reached.
• Due diligence – The buying bank reviews the mortgage terms, creditprofile, properties, and documentation. 
• Sale and transfer – After approval, the sale is executed. The buyer pays the seller and the servicing rights officially transfer.
• Servicing – The purchasing bank or entity begins collecting payments, maintaining records, and servicing the borrowers. 

Proper agreements and legal transfers ensure the process flows smoothly between banks and lenders.

What Are the Risks Involved in Buying and Selling Mortgages for Banks?

While mortgage transfers carry benefits, risks are also inherent for both buying and selling institutions:

For sellers:

• Prepayment risk – Borrowers may refinance and pay off loans sooner than expected, reducing profits.
• Default risk – Delinquent loans result in losses if the borrower defaults. The original lender remains partly exposed to this risk. 

For buyers:

• Credit risk – Inaccurate credit info or appraisals can mean the loans are riskier than expected.
• Interest risk – Rising rates could slow prepayments but also reduce the value of the fixed-rate mortgages purchased.

Careful due diligence, diversification, and risk analysis help institutions manage these hazards.

How Does the Sale of a Mortgage Affect the Borrower?

When a homeowner’s mortgage is sold, the borrower is notified of the change. However, the mortgage terms and conditions themselves do not change. The new institution simply begins collecting payments and handling servicing functions.

Some impacts to the borrower may include:

• Payment address changes to new servicer 
• Account numbers or process changes
• Online account access setup with new servicer 
• New points of contact for questions

But the mortgage agreement, including the interest rate, monthly payment, loan amount, and other terms, remains intact per federal law. Overall impact is usually minimal from a consumer perspective when their bank sells off their home loan.

What Are Some Major Players in the Secondary Mortgage Market?

Some key institutions driving secondary mortgage market activity include:

1. Fannie Mae

Fannie Mae is a government-sponsored enterprise that buys mortgages from lenders, bundles them into mortgage-backed securities, and sells these to investors. This provides liquidity to banks to issue new loans. Fannie Mae deals in conventional loans backed by the government.

2. Freddie Mac

Freddie Mac performs a similar role as Fannie Mae – securitizing conventional loans for sale to investors. Freddie Mac and Fannie Mae guarantee trillions in mortgages against default risk. 

3. Ginnie Mae

Ginnie Mae bundles government-insured loans like FHA and VA loans into securities and guarantees timely payment of principal and interest to investors. 

4. Private Institutions

Many private lenders also participate in the secondary mortgage market by buying and selling loans. These include banks, credit unions, mortgage banks, hedge funds, insurers, and REITs. Private capital helps fund mortgages and provide market liquidity.

What Should You Know If Your Mortgage Is Sold to Another Bank?

If you receive notice that your mortgage was sold, here are some key things to keep in mind:

• The sale doesn’t impact your loan terms, rates, or contractual obligations. 
• Make sure to begin sending your payments to the new servicer to avoid issues.
• Check that your loan details, amounts, and statements are accurate with the new servicer. 
• Understand you’ll interact with a new bank or lender going forward.
• Get in touch with the new servicer with any questions or concerns about your mortgage.

Though some adjustment may be required, you can take comfort that the sale itself does not negatively impact your finances or situation as a homeowner.

Conclusion

The secondary mortgage market involves lenders and banks buying and selling existing home loans to gain several advantages, such as improving liquidity and spreading risk. For borrowers, a sold mortgage primarily impacts where you send your payments and receive servicing. This common practice allows banks to strategically manage their lending portfolios and provides continuity in home financing for consumers.

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