Need a Mortgage? It’s Time to Meet Fannie Mae and Freddie Mac

Read Time: 4 minutes

Fannie Mae and Freddie Mac won’t loan you a dime and yet they have a huge role in the mortgage marketplace. What are they, and why do they matter? The answer involves trillions of dollars and the way homes are financed.

To understand the value of Fannie Mae and Freddie Mac let’s start with Smith Mortgage. It’s a lender in your town and has $12 million available to finance local homes.

If buyers want $250,000 for the typical mortgage it means Smith can finance 48 homes. That’s it. Once it has originated 48 loans it’s burned through all of its available capital (48 x $250,000 = $12 million). If you are borrower #49 you’re out of luck. There’s no money for you. 

This is not just a borrower problem. To stay in business Smith requires more cash. To earn new fees and profits it needs more loan originations.

What can Smith do? It can raise money by selling off assets and the important asset it has are those 48 loans.

Smith could advertise and say it has loans for sale, but that raises questions. What’s the interest rate for each loan? What are the borrower credit scores?

How much money was put down by each borrower? Does each borrower have the ability to repay the debt? What are the specific terms of the loan agreement? Are there prepayment penalties? Balloon payments? 

You can see the problem. Two $250,000 mortgages may have very different terms and thus very different values for investors. Figuring out the marketplace worth of each loan might require dozens of different calculations if not more. 

With Fannie Mae and Freddie Mac, such concerns disappear.

The Secondary Market

The mortgage lenders you see online and down the street are public-facing financing sources. Behind the scenes, there’s what’s called an electronic “secondary market” that makes a lot of mortgage lending possible.

And the most prominent players in the secondary market are Fannie Mae and Freddie Mac, companies started long ago by the federal government, companies also known as GSEs or government-sponsored enterprises. 

The system works like this:

Fannie Mae and Freddie Mac get money from investors worldwide. Such investors include pension funds, insurance companies, ultra-wealthy individuals, and so-called “sovereign” funds that countries use to diversify their economies.

With cash on hand, Fannie Mae and Freddie Mac turn around and say to mortgage lenders, “We’ll buy your mortgages if they meet our standards.”

Smith Mortgage knows that Fannie Mae and Freddie Mac have cash and that it can instantly sell its 48 mortgages if they meet GSE standards. Mortgages that the GSEs buy are called “conforming” loans because they, well, conform to Fannie Mae or Freddie Mac standards.

Once it sells its loans, Smith Mortgage has new capital. That’s money it can use to originate additional loans, generate more revenue, and earn new profits. 

It can also happen that Smith may not want to sell all of its mortgages right now or at all. The financing it keeps are called “portfolio” loans.

Such loans do not have to meet conforming loan standards, but they often do just in case Smith wants to quickly sell them in the future.

Fannie Mae, Freddie Mac & Conforming Mortgage Standards

Smith has a ready market for its mortgages because they’re conforming loans. But what are conforming mortgages? 

You could, for example, check the Fannie Mae single-family guidelines. The edition published in July 2023 runs 1,180 pages.

But, a more practical approach is to look at a few of the standards you can find with conforming mortgages. For instance:

  • There is a conforming loan limit that depends on the number of units being financed (1-4), the jurisdiction where they are located, and whether the property is in a “high-cost” area. Those who need larger loans must apply for “jumbo” financing. 
  • You can’t finance with unlimited debt. The conforming rules generally allow a 45% debt-to-income ratio (DTI) for qualified borrowers, but lenders will sometimes allow additional debt for borrowers who have offsetting compensating factors such as a big down payment, high credit scores, or larger reserves. 
  • You must have equity to get a conforming mortgage. Lenders generally want purchasers to buy with 20% down, but with mortgage insurance conforming loans that require as little as 3% down are available. 

The purpose of such guidelines is to reduce marketplace risk, not just for borrowers but also for lenders and investors. The benefits of a marketplace with little risk include low mortgage rates, few foreclosures, and an ongoing supply of investor capital to local markets whether you live in a big metro area or a small town.

The Worldwide Market for US Mortgages

In the same way that lenders can sell their loans in the secondary market, Fannie Mae and Freddie Mac do something similar. They take their mortgages, bundle them together into mortgage-backed securities, and sell interests to investors in the US and overseas.

Investors know what they’re getting because all loans sold through the GSEs are conforming. And US mortgages, it should be said, are desirable worldwide because of our strong economy, stable legal system, and infrequent loan defaults.

Peter G. Miller

Peter G. Miller is a nationally-syndicated columnist, the author of seven books published originally by Harper & Row (including one with a co-author), and has contributed to leading online sites and major print publications. He has appeared on numerous media outlets including the Today Show, Oprah!, CNN, and NPR.

Peter has been an accredited correspondent on Capitol Hill and a member of the White House Correspondents Association. He has served with the District of Columbia National Guard and holds both BA and MS degrees from The American University in Washington, DC. View Peter on LinkedIn.

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