How does Fannie Mae work?
The Federal National Mortgage Association (FNMA), commonly referred to as Fannie Mae, is a government-sponsored enterprise (GSE) that provides a stream of funds to the housing market to prevent it from failing. This company was chartered by the federal government to provide financial support after the Great Depression. Fannie Mae promotes a secondary market, purchasing home loans from lending companies, such as banks and credit unions. The GSE essentially removes mortgages from their books so that they can issue more loans.
After purchasing these mortgages, the enterprise pools them together into mortgage-backed securities to sell to investors. Along with the GSE, borrowers, lending companies and investors, a part of Fannie Mae stock play a fundamental role in the success of the housing finance system. Furthermore, the company has put into place stringent selling guidelines for lending companies to follow in order to avoid unethical lending practices of high-risk loans. To learn more about Fannie Mae guidelines and how the GSE operates, review the following sections.
Investing in the Housing Market
Although Fannie Mae does not directly provide mortgages to home buyers, it makes the practice of lending possible by investing into the housing market. The enterprise provides funds to approved lenders so that they have a sufficient supply of capital in order to keep producing mortgages. Banks and credit unions are responsible for originating mortgages for their unique buyers that fit the program’s guidelines. These home loans are referred to as conforming or conventional mortgages and meet the GSE’s underwriting requirements.
The company will purchase these loans and either hold the mortgage in its own books or bundle them up and sell them as mortgage-backed securities (MBS). The investment banks or insurance companies that invest in these bonds are guaranteed principal and interest from their mortgages. These shareholders then receive their portion of the deal through monthly payments distributed by a trust. By selling these bonds, the FNMA has the necessary funds to supply to lenders. As a result, millions of homebuyers are able to afford housing.
Download our comprehensive guide to learn more about how Fannie Mae affects you.
Fannie Mae Stock
In 2008, Fannie Mae was taken into conservatorship by the U.S. government due to its collapse in the mortgage crisis. Before then, the GSE heavily relied on the New York Stock Exchange (NYSE) to fund its operations. At the time, there were not as many restrictions and guidelines that monitored the lending of subprime loans through unethical lending practices. Banks and credit unions were issuing home loans with high interest rates to borrowers with a history of delinquent finances.
This cause the Fannie Mae stock to decline substantially below the NYSE’s minimum capital requirement. Investors quickly withdrew their funds from banks, and homeowners all around the country faced foreclosure due to their inability to meet mortgage payments. Today, the GSE is overseen by the Federal Housing Administration (FHA) and is no longer listed in the NYSE. Instead, Fannie Mae trades privately. Furthermore, the enterprise has established a Fannie Mae selling guide to avert the lending of high-risk loans.
Doing Business With Fannie Mae
In order to do business with Fannie Mae, lending companies must adhere to Fannie Mae guidelines. A lender serves as the middle man between borrowers and the GSE, ensuring that loan applicants are capable of paying back their mortgages. How does a lender determine an applicant’s mortgage loan performance? He or she must follow the Fannie Mae selling guide, which includes the proper way to originate and underwrite a mortgage loan. The underwriting process enables lenders to assess and identify potential risks based on an applicant’s financial history.
It is the lender’s duty to collect and document an applicant’s income, assets and liabilities, and debt-to-income ratio. Fannie Mae will then have the final say in whether an applicant is approved or denied for a home loan. If there are any issues regarding the type of the loan the lender has submitted on behalf of the homebuyer, the lending company must resolve them or the mortgage will be dismissed from the process. Upon approval, the FNMA will purchase the loan and start the securitization process. Once the loan has been sold to investors, it is the lender’s responsibility to collect monthly mortgage payments from the borrower.
The lender will keep a servicing fee and pass the principal and interest over to Fannie Mae. As promised, the GSE will covert these funds into a trust that will distribute monthly payments to shareholders. These shareholders can review the status of their mortgage-backed securities through monthly disclosures. If all parties do their parts appropriately, the housing market will continue to run successfully.
To learn how you can take advantage of Fannie Mae services, download our in-depth guide.
When does Uncle Sam save Fannie Mae?
When purchasing a loan from a lending company, Fannie Mae can either keep the loan in a retained portfolio or sell it as an MBS. If the GSE decides to keep the loan in its books, it will issue agency debt to funds its own portfolio. If the FNMA accumulates too much debt and cannot supply sufficient funds to approved lending companies, the U.S. Treasury may supply capital to keep the GSE from failing. Although the government is not directly obligated to fund Fannie Mae, the federal government typically does everything in its power to keep the enterprise running profitably in sake of the housing market.
The amount of home loans a lending company can distribute is ultimately dependent on the amount of investors willing to invest in MBSs. If investors are unwilling to invest in the market due to a bad economy, the less accessible mortgages will be for homebuyers. This becomes a domino effect, in which low- to moderate-income homebuyers are unable to afford housing due to the lack of Fannie Mae loans. As a result, the U.S. Treasury may provide funding in place of these investors to maintain a housing mortgage system.
What happens if borrowers cannot pay their Fannie Mae loans?
If a borrower has defaulted on his or her mortgage payments, he or she may apply for a loan modification. These modifications are necessary when unexpected events occur in a borrower’s life that hinders his or her finances. This may be experiencing a death in the family, losing a job or having unforeseen medical expenses due to an accident. These modifications were put into place to relieve the financial stress of borrowers who cannot pay their home loans. Furthermore, they assist homeowners who may have houses in foreclosure. Modifications may include reducing the interest rate of a mortgage or extending the term of a loan to lower monthly payments.