The Primary-Secondary Mortgage Spread
The rate a homeowner pays on a new mortgage sits above the yield investors demand on the mortgage-backed security it gets pooled into, and that gap pays for origination costs, servicing, guarantee fees, and the lender's profit margin.
The "primary" market is where a borrower gets a mortgage from a lender at a quoted rate; the "secondary" market is where that mortgage, once pooled with others, trades as a mortgage-backed security at a yield set by investor demand. The primary-secondary spread is the gap between the two, and it isn't pure profit — it has to cover the guarantee fee charged by an agency like Fannie Mae or Freddie Mac for insuring the pool against default, the ongoing cost of servicing the loan, the lender's origination costs, and only after those, whatever margin is left.
The spread widens and narrows with market conditions: when mortgage originators are swamped with refinancing volume, they have less incentive to compete on rate and the spread widens, and it also widens when the risk or cost of hedging a pipeline of locked-in rates increases, such as during periods of rate volatility.
The primary-secondary mortgage spread pays for guarantee fees, servicing, and origination costs before any of it is profit, and it widens when originators are capacity-constrained or hedging costs rise, not just when lenders decide to charge more.
If the current-coupon MBS yield investors demand is 5.5% and a borrower is quoted 6.25% on a new 30-year mortgage, the roughly 75 basis point primary-secondary spread covers the guarantee fee, servicing strip, and origination costs baked into that quote.
Related concepts
Practice in interviews
Further reading
- Fabozzi, The Handbook of Mortgage-Backed Securities