What Are Fannie Mae & Freddie Mac?
What are Fannie Mae and Freddie Mac, and how do they help homeowners? Find out how these programs work and why they're important.
Fannie Mae and Freddie Mac are government-sponsored enterprises (GSEs) that make financing home purchases more accessible to consumers. They also provide liquidity, affordability, and stability throughout the mortgage market.
Although Fannie Mae and Freddie Mac are separate entities, together they provide similar and complementary services. The Federal Housing Finance Agency (FHFA), an independent regulatory agency, provides oversight for both programs.
What is Fannie Mae?
Fannie Mae is short for the Federal National Mortgage Association (FNMA). It was established by Congress in 1938 and made possible by the Federal Home Loan Bank Act of 1932, which also created the Federal Home Loan Banks, 11 national banks which lend to other institutions that help homeowners finance their homes. These institutions include credit unions, insurance companies, loan associations, building associations, and other insured depository institutions.
Fannie Mae became a shareholder-owned company in 1968. It wasn’t until the housing crisis in 2008 that the FHFA intervened to bail out Fannie Mae (and Freddie Mac), which had both been on the verge of collapse. Fannie Mae remained listed on the New York Stock Exchange (NYSE) until 2010, but now trades through broker-dealer networks, or what is more commonly referred to as over-the-counter trading.
Fannie Mae primarily buys mortgages from the Federal Housing Administration and banks. With this extra revenue from these sales, banks have more funds at their disposal to lend to additional home loan applicants.
What is Freddie Mac?
Freddie Mac is short for the Federal Home Loan Mortgage Corporation (FHLMC). It was established in 1970, two years after Fannie Mae transitioned from a government agency to a company. It was created in order to foster competition between Fannie Mae on the secondary market and now operates much in the same way, by purchasing mortgages from small banks and then pooling them together for resale.
Fannie Mae and Freddie Mac both act as middlemen between mortgage lenders and investors. To put it in more familiar terms, mortgage lenders are to the secondary market as retail stores are to suppliers. Thus, Freddie Mac products like Home Possible are available directly to banks, not consumers. Banks subsequently facilitate these programs by issuing loans that conform to FNHA guidelines and limits.
What Do Fannie Mae & Freddie Mac Do With The Mortgages They Buy?
Fannie Mae and Freddie Mac repackage the mortgage loans they buy. Subsequently, they are able to guarantee those mortgages through the secondary market, in which investors trade stocks with each other. These are commonly referred to as mortgage-backed securities (MBS). Fannie Mae has become the largest purchaser (along with Freddie Mac) and guarantor of mortgages on the secondary market.
The repackaged mortgage-backed securities are purchased by institutions like investment banks, pension funds, and insurance companies. These institutions prefer purchasing mortgage-backed securities because of the guarantee of principal payments plus interest.
How Are Fannie Mae & Freddie Mac Funded?
Fannie Mae and Freddie Mac fund their investments using corporate debt securities. Also known as a corporate bond, corporate debt securities are sold to investors and rely on future profitability of a corporation.
And when it comes to profits, both Fannie Mae and Freddie Mac have seen significant yields since coming under the conservatorship of the FHFA. $120 billion was disbursed to Fannie Mae in 2008. Since then, it has paid back $185 billion. An additional $71.6 billion was allocated to bail out Freddie Mac, which has since generated $122 billion.
What is the Difference Between Fannie Mae and Freddie Mac?
An important difference to note between these two GSEs is where they buy mortgages from. Fannie Mae primarily purchases mortgages from business or commercial banks. Commercial banks service both retail and corporate customers, from individuals looking to open a savings account or apply for a loan to businesses who need corporate financing and asset management. These include major banks like Wells Fargo, Chase, and Bank of America.
Freddie Mac, on the other hand, buys mortgages from smaller depositories such as thrift banks, which are community-based financial institutions that primarily offer high-yield savings accounts and home loans. Thrift banks may be more commonly known as mutual banks or savings and loan associations.
How Do These Programs Help the Housing Market?
Fannie Mae facilitates liquidity, predictability, ethical lending practices, and loan modifications to help homebuyers. Together with Freddie Mac, it boosts the market and ensures that lenders always have available funds.
Liquidity for Lenders
Fannie Mae and Freddie Mac create liquidity for lenders when they purchase mortgages. Liquidity refers to how quickly an asset may be sold in the stock market without losing its inherent value. When talking about liquidity, cash is king—and when they buy mortgages, Fannie Mae and Freddie Mac are essentially paying the entirety of the loan amount upfront so that loaning institutions can then issue mortgages to even more prospective homebuyers. In this way, Fannie Mae and Freddie Mac indirectly help consumers and directly benefit lenders.
Predictable Long-Term Loans for Homebuyers
Before the creation of Fannie Mae, there were no long-term fixed-rate mortgages, making becoming a homeowner difficult for most Americans. With the introduction of 30-year fixed-rate mortgage loans, homebuyers could expect reliable, long-term payments. Fannie Mae also offers HomeReady and HFA Preferred loans to commercial lenders, who can then offer borrowers down payments as low as 3%.
Freddie Mac offers 15-, 20-, and 30-year fixed-rate mortgages in addition to its own unique programs, like Home Possible loans, which help make buying a home more accessible for those who earn less than 80% of Area Median Income. They also offer Affordable Seconds, which allows for subsidized secondary financing from the federal or state government and even nonprofit community organizations.
Avoidance of Unethical Subprime Lending
Another way Fannie Mae and Freddie Mac help protect the housing market is through its strict criteria for the kinds of mortgages they buy. Leading up to the 2008 financial crisis, Fannie Mae and Freddie Mac acquired risky mortgages, including adjustable-rate and negative-amortization loans, in order to compete with Wall Street's expanding influence.
With subprime loan lending practices, loans with high interest rates are offered to borrowers with bad credit who lenders deem to be “high risk”. When home prices were high, home equity prevented most homeowners from defaulting on these loans. But when home values plummeted and people lost their jobs, many simply walked away from their homes.
Although Fannie Mae and Freddie Mac did not solely cause the financial crisis, the proliferation of subprime lending contributed to the housing bubble burst and subsequent Great Recession. Since they were bailed out and put under the conservatorship of the FHFA, stricter guidelines have been established to prevent high-risk loan practices in the future.
Loan Modifications & Refinancing
Fannie Mae and Freddie Mae also offer loan modifications on existing mortgages. Loan modifications like Freddie Mac Flex Modification help struggling homeowners avoid defaulting on their loans by lowering their interest rates or extending the loan term. This saves thousands of homeowners from going into foreclosure and losing their homes.
Refinancing programs such as Fannie Mae’s HomeStyle Renovation Mortgage allow homeowners to combine financing for significant home renovations with their existing home loan (up to 75% of the property’s as-completed value).
Fannie Mae and Freddie Mac are massive GSEs whose history and business operations are long and complex. The programs have changed tremendously since their inception, but their mission remains the same: to help make buying a home a reality for more Americans. Loans from Fannie Mae and Freddie Mac have competitive benefits on par with FHA loans, but it’s important to remember that both require specific conditions in order to qualify.