Fannie Mae 101
Fannie Mae, also known as the Federal National Mortgage Association (FNMA), is a government-sponsored enterprise (GSE) that was created in 1939 to promote a secondary market for home loans. It was established after the Great Depression, a time when a quarter of Americans lost their homes due to debt. Banks were collapsing at an alarming rate and were unable to provide mortgages to even the most qualifying homebuyers. Fannie Mae purchased mortgages from banks to clear up debt and provided them with enough supply to continue issuing loans. In 1989, Freddie Mac was established to prevent FNMA from becoming a monopoly.
Today, these enterprises are the leading sources of liquidity for the housing market, owning or insuring trillions of dollars in home loans. Fannie Mae purchases and sells mortgages to investors through mortgage-backed securities (MBS). In efforts to reduce high-risk mortgages, the company enforces a comprehensive underwriting process for lenders to follow. To learn more about how this GSE works, read the following sections.
How does Fannie Mae work?
Fannie Mae provides stability, accessibility and liquidity to the housing market by investing into it. Lending companies, such as banks and credit unions, do not have to wait 30 years for a loan to be restored. Instead, the FNMA removes the mortgage loan from a bank’s books by purchasing it and selling it in the form of a mortgage-backed security (MBS). The enterprise relies on lenders to originate high-quality loans and investors to buy them for their principal and interest. Each group must fulfill their roles to keep the mortgage market active so that homebuyers can afford housing.
The lender is responsible for gathering the accurate and vital information regarding a borrower’s eligibility for Fannie Mae loans. It is also the lender’s responsibility to service the loan and collect the homeowner’s monthly payments. Fannie Mae guidelines are set to ensure that banks and credit unions are issuing mortgages to homebuyers who have the capacity to repay them. The government-sponsored enterprise (GSE) also guarantees investors a monthly payment of accrued principal and interest, even if the borrower is not meeting his or her mortgage payments. In the event of a financial crisis, the government may step in to provide debt relief to keep the system from falling apart.
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What are mortgage-backed securities?
Mortgage-backed securities (MBS) are bonds of a home loan or a collection of loans that are sold to investors in exchange for principal and interest. These include pension funds, investment banks, insurance companies and other financial institutions. FNMA purchases loans and pools them together into MBSs, allowing lending companies to replenish their funds so that they can continue to issue mortgages. Furthermore, the institutions that invest into Fannie Mae are guaranteed their portion of the share through monthly payments.
While this seems like a win for investors, they must also be wary of the risks of MBSs. If a borrower pays off his or her mortgage loan sooner than expected, that means investors do not receive interest for the duration of what was expected initially, the term length of the loan. Additionally, a borrower may decide to refinance his or her home if interest rates decrease to a desirable amount. This also means that investors will not receive their interest as promised.
Shareholders have the option of investing in two types of home loans: pass-through mortgages and collateralized mortgage obligations. Pass-through MBSs are much simpler and typically involve the lending company, Fannie Mae and a pool of investors. On the other hand, a collateralized MBS is more complex and involves a hierarchy of securities. Fannie Mae offers mortgage-backed securities for both single-family and multifamily properties. These MBSs consist of fixed-rate or adjustable-rate mortgages, but never a combination of the two.
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The Origination and Underwriting Process
Fannie Mae learned its lesson after the 2008 mortgage crisis that led to an overwhelming amount of foreclosed houses due to subprime loans issued to borrowers with poor credit. Since then, the enterprise has established a strict Fannie Mae selling guide regarding the origination and selling of a mortgage. To be approved for a Fannie Mae loan, both the borrower and lending company must undergo a number of steps to meet eligibility requirements. These steps are enforced to ensure that homebuyers are completely capable of meeting their mortgage payments on time.
Homebuyers must complete a loan application and provide accurate, up-to-date information and documentation that determines their income, employment, assets and liabilities. If the applicant has any debt or declarations, such as child support obligations, he or she must provide that information. Lenders assist applicants throughout the process by assessing their financial situations and informing them of mortgage options that fit Fannie Mae guidelines before underwriting and originating a loan. For example, mortgages bought by the enterprise must not exceed the loan limits or the set allowable amount for that year.
If the loan limit for a single-family home is $453,100 in the applicant’s area, he or she will not be able to receive a loan that exceeds this amount. Banks issuing loans must use the comprehensive risk assessment approach or the GSE’s Desktop Underwriter (DU). These systems evaluate an applicant’s entire financial situation and determines his or her risk as a borrower.
Fannie Mae vs. Freddie Mac
Fannie Mae and Freddie Mac are both corporations chartered by the U.S. government. Additionally, they both serve the same purpose in promoting a secondary mortgage market to keep the housing market strong and stable. Both enterprises are managed by the Federal Housing Association (FHA) and have the same yearly loan limits and offer the same type of loans to their borrowers. However, they do have a few notable differences.
For example, Freddie Mac purchases home loans from smaller financial institutions while Fannie Mae pools together loans from larger corporations, such as Bank of America. Furthermore, Freddie Mac is 100 percent backed by the federal government in the event of a financial crisis, while the government is not directly obligated to provide funds to Fannie Mae. These GSEs also have a few differences in their origination and underwriting processes. This is mainly due to their automated underwriting systems. While one borrower may be approved for a Freddie Mac loan, he or she may not be approved for a Fannie Mae loan.