Primary Mortgage Market: What it is, How it Works (2024)

What Is the Primary Mortgage Market?

The primary mortgage market is the market where borrowers can obtain a mortgage loan from a primary lender. Banks, mortgage brokers, mortgage bankers, and credit unions are all primary lenders and are part of the primary mortgage market.

How the Primary Mortgage Market Works

Homeowners can deal directly with primary lenders when shopping for a mortgage loan by contacting their local bank. For most borrowers, they won't notice that they're dealing in the primary mortgage market since they'll interact with their mortgage representative at their local bank during the entire process. The mortgage professional will educate the borrower about the various types of mortgages available and quote the interest rate depending on which type was chosen. The local branch will usually be the location for the loan closing—where the paperwork is signed.

Many borrowers also start the home-buying process by contacting a mortgage banker or mortgage originator. Originators and mortgage bankers are not banks per se, but instead, help facilitate the transaction and refer the mortgage request to a bank to close the loan. The brokers get a fee for their service since they refer business to primary lenders. The borrowers, on the other hand, stand to get a better rate by having the broker shop around for the best deal depending on borrower's credit and the desired terms.

However, it's important to note that the Consumer Financial Protection Bureau has implemented regulations regarding compensation for mortgage brokers. Before the financial crisis, brokers could receive compensation from the borrower as well as the lender. Consumers were unaware that the broker was getting paid by the lender when they paid their fee. Also, brokers had incentives to steer consumers to more expensive products or mortgages and sometimes, higher interest rates. Since the Great Recession of 2008 and 2009 and the resulting regulations that followed, the number of mortgage brokers has declined.

Benefits of the Primary Mortgage Market

There are some benefits available to borrowers who transact in the primary mortgage market, which can include:

Low Closing Costs

Primary lenders are typically locally-owned banks, which means that they do the credit analysis and underwriting process. Underwriters review a borrower's financial information and credit history to decide whether to extend credit or deny the loan. Also, local banks prepare all of the paperwork and documentation in-house instead of going through a centralized unit out of state as is the process for some large banks. The result can be lower fees with a local bank since they have less overhead versus a larger bank. Also, if a mortgage broker got involved in finding the bank, a fee will be assessed as well. In short, opting for a locally-run bank for a primary mortgage can help reduce closing costs.

Small Down Payments

Typically, the down payment for a mortgage is 20% of the purchase price of the home. However, a borrower can put down less money, and many primary lenders offer a 10 percent downpayment.

For low-to-moderate income borrowers, an FHA loan offers a down payment as low as 3.5% of the value of the home. FHA is theFederal Housing Administration, which offers insurance to lenders so that they can issue loans to low-income borrowers.

However, a down payment of less than 20% triggers the need for the borrower to purchase private mortgage insurance or PMI. PMI protects banks and lenders in case the borrower defaults on the mortgage. PMI is a monthly fee charged to the borrower until 20% of the mortgage loan has been paid off.

Flexibility

Because the originators of the loan are typically locally-owned banks, it is more likely that the borrowers will be able to communicate with the people who get the final say, which is unlikely to happen at a national bank. The direct contact can provide flexibility if the borrowers have a unique financial situation.

The flexibility can include offering a fixed-rate 15-year versus a 30-year mortgage if the borrower is looking to pay off the loan sooner. Some of the advantages to a 15-year mortgage include less total interest charges since it's paid off earlier. Also, borrowers can usually negotiate a lower interest rate since there's less risk of the borrower defaulting, or not paying off the loan due to financial hardship. Of course, a big advantage to a 30-year mortgage is that it offers lower payments since they're spread out over a longer period versus other terms.

Adjustable rate mortgagesare a flexible option that are usually offered for consideration. ARM loans usually come with a fixed interest rate for a set period of time and then adjusted annually on an index that was pre-determined by the lender and the borrower. Typically, ARMs come with a cap on how high the interest rate could go during the lifetime of a loan, which makes it easier to calculate and budget for your maximum monthly payment.

Primary Mortgage Market vs. Secondary Mortgage Market

The primary market is made up of primary lenders. Primary lenders typically keep the loans they originate as part of their portfolioand service them for the life of the loan. However, the bank that made the mortgage loan can sell the loan in the secondary mortgage market, which is a market where investors can buy and sell previously-issued mortgage loans. A mortgage can be sold to another lender or service company, which processes the payments for the loan. The new lender or service provider earns money from fees and interest on the mortgage.

Many mortgages are purchased by Fannie Mae or theFederal National Mortgage Association(Fannie Mae, or FNMA). Fannie Mae turns around and packages the loans and sells them as investments called mortgage-backed securities (MBS), which are similar to mutual funds but contain mortgages instead of stocks. Investors earn the interest rate from the mortgages for holding the MBS.

If your mortgage is sold, please know that it's a common practice in the financial industry. Banks have lending limits, meaning they have caps as to how much of their deposit base they can lend. The sale of a mortgage loan to Fannie Mae or a service provider removes the loan from the bank's books allowing it to lend out more money. If banks couldn't sell off their mortgages, they'd reach their lending caps and wouldn't be able to offer any more mortgages, which would slow the economy. However, unless you're an investor looking to purchase an MBS, you won't deal with the secondary market. Instead, you'll deal with a bank or broker in the primary mortgage market.