What Is Fannie Mae?
Federal National Mortgage Association (FNMA)
Fannie Mae refers to the Federal National Mortgage Association (or FNMA).
Established in 1938 as part of Roosevelt’s “New Deal,”Fannie Mae was commissioned by Congress to purchase or guarantee existing mortgage loans to allow banks and other mortgage issuers freed up capital for issuing additional loans.
Fannie Mae typically purchases mortgage loans from larger, commercial banks, and its sibling Freddie Mac, or the Federal Home Loan Mortgage Corporation, typically purchases mortgage loans from smaller banks and lenders.
Fannie Mae and Freddie Mac are largely responsible for the creation of a secondary mortgage market which buys pre-existing mortgages.
How Fannie Mae Works
After Fannie Mae has purchased a pre-existing loan and the underlying mortgage, it will package a group of these mortgages into a financial instrument known as a “mortgage backed security.”
Regulations Around Fannie Mae
There are two regulations on Fannie Mae put in place to allow this model to work. First, Fannie Mae is only able to guarantee loans up to the conforming loan limit, which is anything lower than the annual mean housing price of an area.
Second, Fannie Mae is legally compelled to purchase any loans which meet its underwriting standards, regardless of economic conditions.
Any loan above the conforming loan limit is called a “Jumbo loan.”
Because Jumbo loans are not purchased by Fannie Mae, there is significantly less demand in the market for them, making loans above the mean home value much more expensive, ranging from a 0.25% to 1.5% increased APY.
Although still an important player in the secondary mortgage market today, Fannie Mae suffered significant losses during the 2008 financial crisis and many private label securitization entities have filled the supply gap in the secondary mortgage market.
Explaining Fannie Mae in Simple Terms
To summarize, Fannie Mae purchases mortgages from the original lender in order to free up the lender’s capital to offer additional loans, especially among low- and moderate-income borrowers.
In order for Fannie Mae to continue purchasing more pre-existing mortgages on the secondary market, it creates and sells mortgage backed securities, which provide interest to the investors as well as collateral to provide some backing on the investment.