Fannie Mae and Freddie Mac — respectively the Federal National Mortgage Association and Federal Home Loan Mortgage Corp. — are government-sponsored enterprises, or GSEs, created by Congress to support the nation’s housing finance system. Their mission is to provide liquidity, stability and affordability to the mortgage market.
What do they do?
Fannie and Freddie purchase mortgages from lenders. They either hold these loans in their portfolios or package them into mortgage-backed securities and sell the bundles to investors. By selling mortgages to Fannie and Freddie, lenders get cash they can use to make new loans and keep the mortgage market moving.
“The vast majority of lenders are not banks, thrift [associations], or credit unions… probably at least 70 to 75% are non-bank financial institutions or independent mortgage banks,” Clifford Rossi, professor at the University of Maryland Smith School of Business, told Homes.com in an interview.
By bundling home loans into mortgage-backed securities and guaranteeing payments to investors, Fannie and Freddie make investing in the secondary market safer and more appealing.
This draws in investors who might not otherwise invest in mortgages, thereby increasing the amount of money available for home loans. That extra funding helps keep the mortgage market liquid and helps lower interest rates for homeowners and other mortgage borrowers.
“Private investors, life insurance companies, pension funds, hedge funds and banks will buy the mortgage-backed securities issued by Fannie and Freddie,” Rossi said.
How it works
Fannie and Freddie don’t lend directly to consumers. Instead, they operate in the secondary mortgage market:
- A borrower obtains a mortgage from a lender, such as Bank of America or Wells Fargo. They can hold on to it or sell it off.
- If the loan meets Fannie and Freddie’s criteria (a “conforming loan”), the lender can sell it to one of the government-controlled entities.
- “The lender is making the loan based on the underwriting guidelines that are provided to them by Fannie Mae and Freddie Mac. That loan, once it closes, gets sold with a pool, a bundle of other loans, to Fannie or Freddie,” Rossi said.
- The government-controlled entity either holds the loan or bundles it into securities sold to investors.
- The lender uses the proceeds to fund new loans.
Lenders don’t have a fixed allegiance to either Fannie or Freddie. They use a process called “best execution” to decide where to sell each loan. "The highest price for that loan is where that loan is sold to," Rossi said. "So, if Fannie Mae offers $100,000 and Freddie Mac offers $101,500 for a $100,000 loan, the lender will sell to Freddie Mac to get the best price.”
Who are you borrowing from?
Borrowers get their loans from banks, credit unions or mortgage companies, not Fannie or Freddie. But if the loan is conforming, it's likely to be sold to one of the government-sponsored entities shortly after closing.
Remember, a conforming loan is a mortgage that meets the specific underwriting guidelines set by Fannie and Freddie.
Even if you get your mortgage from a big bank, your loan might be sold and serviced by a different company later. You’ll get a notice if this happens.
What happens after the sale?
When your mortgage is sold by the original lender, you may notice a change in who collects your monthly payments. That original lender sold their right to "service" your loan to another company. This new company is called a mortgage servicer. The servicer is the company you send your mortgage check to each month and is responsible for handling your payments, managing your escrow account and helping you if you run into trouble or need a loan modification.
Even though your loan originated with a familiar bank or lender, it's common for servicing to change hands, sometimes multiple times over the course of a seven-year average loan life, according to Rossi. You'll always get a notice if your servicer changes and you'll be told where to send your payments going forward.
Behind the scenes, your loan may be bundled with thousands of others into mortgage-backed securities, which are sold to investors. These investors buy these securities, receive payments of principal and interest, but they don't have any direct say over your loan terms or servicing.
Fannie and Freddie guarantee payments to investors, even if a borrower defaults. This guarantee is backed by the government, which stepped in during the Great Recession to keep the system stable. Since then, they have remained under government conservatorship by the Federal Housing Finance Agency, or FHFA. The FHFA sets limits on the types and amount of loans Fannie and Freddie can buy, monitors their financial practices and business operations.
There is an ongoing debate about privatization, which means that both entities could eventually return to private ownership and operate with less direct oversight. The Trump administration has been pushing to release them from federal control by the end of this year.