The American free market economy is vibrant, dynamic and always looking for additional, more profitable business opportunities. The non-conforming is one such market for financial investors and lenders.
Fannie Mae, Freddie Mac and Ginnie Mae only serve A-credit borrowers, who meet those agencies' strict guidelines regarding income, employment, assets, property, etc. For a long period, this situation ignored a huge market of people falling outside these "conforming" guidelines.
When financial investors and lenders realized the opportunities available in the non-conforming market, they followed Fannie Mae's lead and created mortgage-backed securities for this underserved market.
Today, the non-conforming market is one of the fastest growing segments of the mortgage industry.
The non-conforming market essentially serves those borrowers who are unable to qualify for conforming loans. These borrowers are considered higher risk, but many investors still see these loans as great investments. The higher risk levels are offset by the higher interest and the fact that the loan is secured by real estate property—if the borrower defaults, the property is foreclosed and sold to pay off the loan.
As mentioned, non-conforming loans are sold to the secondary market in much the same way as conforming loans are sold through Fannie Mae and Freddie Mac.
Private financial institutions purchase from lenders across the nation those non-conforming loans that meet the specific institution's guidelines. That private company then packages multi-million dollar blocks of loans into securities, which are then sold to investors on Wall Street and the financial markets.
Wall Street and the financial markets to which these securitized mortgages are sold is called the secondary mortgage market. By comparison, the primary mortgage market involves lenders and borrowers.
By connecting the residential mortgage market with the broader, more powerful financial market, home buyers receive an increased supply of loan funds. Without this connection into the secondary mortgage market, banks will have a more limited supply of mortgage funds. Again, this abundant supply means relatively lower pricing or interest rates.
Through this process, private financial corporations mimic federally chartered agencies, such as Fannie Mae, to reduce the lender's risk exposure. If one borrower defaults, the losses are diffused among all the parties.
For the Wall Street investors who buy such mortgage securities, they do not bet on a single loan; instead they invest in a piece of thousands of loans (used to create this block of mortgage securities).
Before the advent of the secondary mortgage market, bank loans basically were limited to the deposits that the banks had in their institution. Once those deposits were all loaned out, the bank could not really lend any more funds. In such scenarios, banks were especially hesitant to lend funds to high-risk borrowers.
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