Fannie Mae and Freddie Mac: What Homebuyers Need to Know Now

Although Fannie Mae and Freddie Mac have different programs for borrowers, each plays a huge role in stabilizing the mortgage market and protecting housing.

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With the American economy still clawing its way back from the COVID-19 pandemic, there's a new spotlight on the housing market and whether people actually have — or will have — access to an affordable place to live. One critical dimension to this is the role that Fannie Mae and Freddie Mac play. Here's a bit of a primer, followed by an explanation of what happened this past summer in the second home and investment property space.

Fannie Mae and Freddie Mac — Who Are They?

Fannie Mae (the Federal National Mortgage Association, FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation, FHLMC) are government-sponsored enterprises (GSEs) that purchase mortgages. President Franklin D. Roosevelt established Fannie Mae in 1938 to purchase Federal Housing Administration loans. The intention was to allow for more mortgages to help people afford housing after the Great Depression. Fannie Mae became a public company and started selling stock to shareholders in 1968, but the government still backed its loans. Congress established Freddie Mac to provide some competition for Fannie Mae in 1970.

How Fannie Mae and Freddie Mac Influence the Residential Housing Market and Economy

Although Fannie Mae and Freddie Mac have different programs for borrowers, each plays a huge role in stabilizing the mortgage market and protecting housing. Here's how it works.

Let's say you want to buy a house. You go to your bank and take out a mortgage. The bank now has less money to lend to other people, because they've already loaned some to you. To recoup the money they have lent to you, ensure they can loan to someone else and relieve themselves of the risk of your loan, they sell your mortgage. In 2020, approximately 62% were sold to Fannie Mae or Freddie Mac, clearly showing their outsized influence on the mortgage market. Fannie Mae or Freddie Mac then packages your mortgage with others and sells the package on the secondary mortgage market to investors, such as pension funds and insurance companies, who appreciate the regular income they receive from mortgage payments. When the system functions optimally, lenders can offer more mortgages at lower interest rates, and Fannie and Freddie, as well as their investors, earn a return on their investment.

How the Housing Bubble Resulted in Receivership

Leading up to the housing crisis that led to the Great Recession in 2008, Fannie Mae and Freddie Mac operated as shareholder-owned, for-profit companies, even though they were technically backed by the full faith and credit of the U.S. government. Although they were not the only organization guaranteeing mortgages, they handled 40% of the market by 2007. Because of their huge market share, many lenders structured their mortgages based on Freddie Mac and Fannie Mae's standards (e.g., your required down payment) to make them sellable.

When borrowers began defaulting on their loans, Fannie Mae and Freddie Mac were in financial trouble. That's when the U.S. government decided they were "too big to fail." They were provided the capital and liquidity they needed to continue operating (some $191 billion) and they found themselves in receivership. The receivership still stands today, well over a decade later.

Shifts in PSPA Provisions

Given that Fannie Mae and Freddie Mac are in receivership, their regulatory agency, the Federal Housing Finance Agency (FHFA), consults periodically with the Treasury and crafts agreements about how Fannie Mae and Freddie Mac can exit bankruptcy. These agreements are called Preferred Stock Purchase Agreements (PSPAs).

In the final days of the Trump administration, led by then-Treasury Secretary Steven Mnuchin, leaders added new provisions to the PSPAs that restricted the ability of Fannie Mae and Freddie Mac to support specific options, including loans to lower down payments, less credit-worthy borrowers, second homes and investment properties. Because Fannie Mae and Freddie Mac were restricted in how much they could buy of these types of loans, mortgage lenders raised their interest rates on them or in some cases, stopped lending to loans with these characteristics altogether — the net result of which made financing these properties more expensive.

On September 14, 2021, the FHFA suspended these portions of the Trump administration's new PSPA provisions. They can also, temporarily at least, go back to guaranteeing the way they did before.

In theory, suspending those provisions will lower housing loan interest rates, allow more people to buy and make more homes available for rent. Some critics, Republican Senator Pat Toomey among them, have subsequently argued that suspending the PSPA provisions will pour too much fuel on the housing market. But the Treasury Department asserts that the suspension emerges from the responsibility to keep both organizations solvent and that it "is not intended to stimulate aggregate housing demand given current conditions in the housing market." It stresses that the suspension aims to give the FHFA and Treasury the opportunity to review "the extent to which these requirements are redundant or inconsistent with existing FHFA standards, policies, and directives that mandate sustainable lending standards."

If You Need a Home To Live In or Rent Out, Now Is the Time To Seek Your Mortgage

Understanding what's happening with Fannie Mae and Freddie Mac can help you make sense of why the housing market has been pivoting so dramatically over the past year and a half. But the major takeaway is, right now, you have a great opportunity to seek out a property loan. With Fannie Mae and Freddie Mac's backing, local financial institutions are in a position to give you better interest rates again.

Of course, the FHFA might reverse the Trump administration's PSPA provisions permanently after its review. But because the fate of those provisions is still unclear, it's wise to take advantage of the reduced cost while you can. Explore your options with local lenders who have a good reputation, and keep your eye on the PSPAs even after you sign to ensure you understand how they influence refinancing or other loan modifications.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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