Fannie Mae (FNMA), How It Works, and How Its Loans Help You

The Two Critical Ways Fannie Mae Helps You

Fannie Mae supports homebuilding.
••• Photo: Justin Sullivan/Getty Images

Fannie Mae is the Federal National Mortgage Association. It is a former government-sponsored enterprise that is under the conservatorship of the Federal Housing Finance Agency. The U.S. Department of the Treasury owns all its senior preferred stock. That means all of FNMA's profits go to the U.S. Treasury. 

What It Does

Fannie Mae buys mortgages from banks, mortgage brokers, and credit unions. That gives banks money to make more loans. It also transfers the risk of default from the bank to Fannie Mae. 

Fannie then packages similar types of loans into mortgage-backed securities. It sells the securities to investors. These include hedge funds, pension funds, other banks, and even individual investors. 

Fannie Mae continues to own the underlying mortgages. It pays the investors their pro-rated share of each month's mortgage payment. That includes both the principal and interest. The Federal Reserve Bank of New York makes the payment through a wire transfer. 

Fannie Mae guarantees the payment. But investors sustain three risks. 

  1. The homeowner could prepay the mortgage. That means the investor receives less than he or she originally thought.
  2. If interest rates fall, then homeowners will refinance. In that case, they will prepay the mortgage. Falling interest rates will lower the value of the MBS. 
  3. The borrower may default. However, Fannie Mae guarantees the payment, so the investor doesn't have that risk. On the other hand, if many borrowers default, it could conceivably overwhelm Fannie Mae's ability to make timely payments. 

Fannie Mae also provides financing for the development of affordable rental housing. A certain percentage of Fannie Mae's mortgages must serve low and moderate-income families.

What Is an FNMA Loan?

An FNMA loan is a mortgage guaranteed by Fannie Mae. Almost all banks and mortgage lenders provide them. A bank must be approved by Fannie Mae to sell them. It must agree to treat you fairly and not sell you shoddy products.

You and the property you want to buy must qualify to receive an FNMA loan. You need a FICO score of 620 or more. Your debt should be no more than 28 percent of your income. The loan should be no more than $427,000. You should be prepared to pay five percent down. Your bank will ask you to fill out FNMA's Uniform Residential Loan Application.

You may also qualify for a HomeReady mortgage. This only requires a 3 percent down payment if your income is below a certain level. You also complete a homeownership education course.

If FNMA owns your existing loan you can save when you refinance. It will also help if you need to modify your mortgage, prevent foreclosure, or need help after a disaster.

History

FNMA was created in 1938 to establish a secondary mortgage market for loans insured by the Federal Housing Administration. In 1968, Fannie Mae became a shareholder-owned company that could buy any mortgage, not just those insured by the government. Its stock was listed on the New York Stock Exchange.

Fannie Mae is often called the sister of Freddie Mac. The Federal Home Loan Mortgage Corporation buys mortgages and packages them into mortgage-backed securities. It is also owned by the government. The Emergency Home Finance Act of 1970 created the FHLMC to compete with Fannie Mae. It could buy any loan and securitize most of them. FNMA was restricted to Federal Housing Association approved loans.

Fannie Mae and Freddie Mac are not only different in their genesis, but also in their target market and products. Fannie Mae buys mortgages from large retail banks. Freddie Mac buys them from smaller thrift ones. 

The subprime mortgage crisis overwhelmed Fannie and Freddie's ability to guarantee all those bad loans. After many bailouts and attempts to keep them solvent, the federal government nationalized the two. 

The Fannie Mae and Freddie Mac bailout occurred on September 7, 2008. Congress authorized the U.S. Treasury Department to purchase up to $100 billion in their preferred stock and mortgage-backed securities. Treasury paid $116 billion for Fannie and $71 billion for Freddie.

Keeping the two afloat cost taxpayers $187 billion over time. In August 2012, the Treasury began sending all Fannie and Freddie profits into the general fund. Since then, the bailout has been paid back with $58 billion in profit. Fannie remitted $147 billion and Freddie paid $98 billion.

FNMA Stock

FNMA stock traded on the New York Stock Exchange until 2010. On July 8, 2010, Fannie Mae announced its preferred and common stock would trade on the OTC Bulletin Board. Investors can still buy common stock and junior preferred stock. The conservatorship doesn't allow FNMA to pay dividends.

FNMA's stock price hasn't recovered because it's still in conservatorship. FNMA shareholders have asked the White House to make Fannie and Freddie private again. They realized the two are a good business investment. Future shareholders could make a good return on investment if the two were private.

That's unlikely to happen. There are many in Congress who would like to dissolve Fannie and Freddie. They see the two as unneeded government interference in the housing market.  

How It Affects the U.S. Economy

Before the crisis, Fannie Mae stimulated the housing market, which made up 9.1 percent of the economy. That created wealth for homeowners who could then afford higher-priced homes. Fannie Mae also allowed low and moderate income families to get a financial cushion beneath them. That gave them a higher standard of living in the form of home ownership.

Fannie Mae was involved in the subprime crisis but did not cause it. Banks repackaged Fannie's mortgage-backed securities into bundles called collateralized mortgage obligations. They took the bundles and sliced them into tranches. For example, they put all the low-interest payments into one tranche. Investors who wanted less risk bought those. Others bought the high-interest payments. Investors were willing to buy such synthetic investments because they were guaranteed by insurance called credit default swaps

In fact, there was such demand for these CMOs that banks became desperate for more mortgages. They needed the mortgages to create the CMOS. As a result, banks sold subprime mortgages to people who weren't credit-worthy. All went well as long as housing prices kept rising.

When housing prices started falling in 2006, no one knew what the CMOs were worth. AIG could not repay all the CDS it had issued. Many people thought Fannie and Freddie caused the subprime mortgage crisis. But, in fact, it was these derivatives.

Following the crisis, Fannie Mae kept the housing industry on life support. As of 2010, housing only made up 2 percent of the economy. Fannie and Freddie now guarantee 90 percent of all mortgages. In other words, banks won't lend anyone without a government guarantee. Before the crisis, they would lend to just about everyone with a pulse

How It Affects You

Fannie Mae helps you in two ways. If you are a homeowner, then Fannie Mae helps keep mortgage costs low by making funding for mortgages more readily available. If you qualify as a low or moderate income family, Fannie Mae will provide you with a mortgage you couldn't otherwise afford.