| It used to be that when someone wanted a
loan for a home he walked or rode to the nearest town to visit the bank. If the bank had extra funds
"lying around," and considered him a good credit risk, it would lend
him the money from those funds.
Things have changed remarkably since
those days. Most of the money for home loans now comes from three major
institutions:
- Federal National Mortgage
Association (FNMA or "Fannie Mae")
- Government National Mortgage
Association (GNMA or "Ginnie Mae")
- Federal Home Loan Mortgage
Corporation (FHLMC or "Freddie Mac")
Federal National Mortgage
Association –
Though a private corporation, Fannie Mae is loosely supervised by the U.S.
Department of Housing and Urban Development (HUD). Congress originally created
Fannie Mae as a government agency in 1938 as a way to raise funds for the home
loan program of the newly created Federal Housing Administration (FHA)
Today,
Fannie Mae raises money for all three primary types of loans (FHA-insured
loans, conventional loans, and loans guaranteed by the Department of Veterans
Affairs) by buying loans that already have been made. It gets the money
for these purchases from the sales of bonds to investors. These bonds are a
relatively safe investment because they are backed by the real estate upon
which the mortgages were made. If the borrower under a loan purchased by
Fannie Mae fails to pay, the property is foreclosed and sold so that Fannie
Mae can recover its investors' money.
Government
National Mortgage Association –
An agency of the federal government under the control of HUD. Created in 1968
when Congress privatized Fannie Mae, Ginnie Mae operates similarly to Fannie
Mae, except that it does not buy conventional loans. In addition to creating a
secondary market for government-guaranteed loans, it also directly makes
low-interest loans for urban development and for housing projects in low-income
areas.
Federal
Home Loan Mortgage Corporation –
Another private corporation created by Congress (under the auspices of HUD) to
help provide money for home loans by selling mortgages on the secondary
market. Congress formed Freddie Mac in 1970 as a way to help banks and savings
and loan associations by creating a secondary market for their loans. (At the same time, Congress gave Fannie Mae
the same authority.) Freddie Mac primarily buys conventional loans, but may
also buy FHA and VA loans. Freddie Mac raises money for loan purchases through
the sale of "mortgage participation certificates" and
"guaranteed mortgage certificates."
How the process works
Here, in a very small nutshell, is a simplified overview of how the process
involving the above institutions works.
Assume that a bank in Iowa has
exactly $200,000 to loan, and not a penny more. A mortgage broker in Oregon
City knows of the money that the Iowa bank has available to loan, and tells a
home buyer about the excellent interest rate that the Iowa bank is offering.
The home buyer decides to accept the
terms being offered on the loan, submits an application to the broker, and locks in the
interest rate. The mortgage broker processes the loan for the Iowa bank, and
the sale closes when the bank pays out the $200,000. Its loan money now gone,
the bank can make no more loans until it receives more deposits. Or can it?
Enter Freddie Mac! With money from
mortgage participation certificates it recently sold, Freddie Mac buys the
loan from the Iowa bank at face value, or $200,000. The bank signs over the
loan note to Freddie Mac, which now begins collecting the loan payments. The
bank then takes the $200,000 it just got from Freddie Mac and goes off to make
another loan.
While it's relatively easy to see in
this example how Freddie Mac could make money for its investors (collecting
the interest that accrues in the loan payments), some people will wonder how
the bank can make any money doing business this way. How does it make any
profit if it's always making and selling loans for equal amounts? The answer
to this is easy too: it makes its money off the loan fees it charges.
Of course, this process of buying
and selling loans would be cumbersome and time-consuming if these big three
secondary market makers approached each lender individually about each and
every loan that was made. To streamline the process, and reduce risk to
investors, each of these institutions has developed specific standards
that apply to the loans that it buys; and each institution only buys loans in packages, or
"pools," that conform to these standards. The standards relate to
such things as maximum loan amounts, property condition requirements, borrower
qualification requirements and so on.
Once an institution like Fannie Mae
purchases a pool of loans, it usually pays a small fee to another company, called a "loan
servicer," to collect the payments for the loans. The loan servicer then
forwards the funds it collects to the institution so that the institution can
repay the investors who bought the institution's bonds.
Thus proceeds a repeating cycle that
produces most of the cash for mortgage lending.
Banks that buy loans
Now we always hear stories about how
loans are continually sold and resold from one bank or mortgage company to
another. Everyone is bound to have heard of a friend or relative who got a
home loan, then had the loan sold several times, often in the first few years
of the loan.
In fact, what happens most of the
time is that the home loan was sold only once, as part of a pool to Fannie
Mae, Ginnie Mae or Freddie Mac. Subsequently, the servicing of the loan
(collection of payments) was sold to another company, then later to another
company, and so on. Just like loans themselves can be sold, so can the
servicing of loans.
Of course, there are banks and other
mortgage companies that make loans without selling them. And the big three
institutions aren't the only entities out there buying loans. Sometimes banks
do buy loans, but these loans that lenders hold onto are typically sub-prime
loans (riskier, high-interest loans), unusually large residential loans, or
large commercial loans. These are loans that the government-chartered
institutions refuse to buy because there is greater risk associated with them.
These higher-risk loans may also be
packaged into different kinds of pools for smaller investors who specialize in
buying high-risk loans. Just as with loans from the government-chartered
institutions, these investors may even back their purchases with sales of
bonds or similar securities.
"Mortgage banking" is the
term often used to refer to this buying and selling of mortgages and mortgage-backed securities.
Mortgage banking is the proverbial backbone of the mortgage business.
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