CNC Mortgage Blog

All the business news during the past few weeks has been reporting on the situation at Freddie Mac and Fannie Mae. I just want to make a short and simple explanation of their importance and operation in the mortgage market.

Both companies are private entities, chartered by the US government to provide mortgage financing for the residential housing market.

Their function is to buy mortgages from banks, bundle them and resell them to institutions that are interested in a long term investment.

An example is probably the best way to illustrate this.

10 borrowers want to get ten loans of $200,000 each. These loans will be mortgages; they will be secured by homes.

The ten borrowers go to mortgage brokers, credit unions, banks and obtain mortgages. So these “originators” have taken $2,000,000 of their capital and lent it to homeowners. If they want to continue lending they need to replenish that money.

These “originators” endorse (sell) the mortgages to Fannie Mae and Freddie Mac for $2,000,000 plus a profit. The originators receive the $2,000,000 and can now lend that money to other homeowners.

Fannie and Freddie now have ten mortgages worth $2,000,000. With these ten mortgages they produce a document called a “mortgage backed security” (MBS) and sell it to institutions who are interested in a secure investment that will produce a steady yield over a determined period of time. These institutions do not want and are not equipped to deal with the individual borrower or even small individual banks and financial institutions.

Fannie and Freddie sell the MBS to institutions such as insurance companies, foreign governments, university endowment funds, charities, pension funds, national and foreign banks and other companies or individuals who have cash and need a secure investment with a steady income stream.

Fannie and Freddie buy one half of the mortgage loans generated in the US, hence their importance in this market. If they were to stop buying mortgages, financing for new mortgages would disappear as soon as all originators had exhausted their own financial resources.