Fannie Mae, or the Federal National Mortgage Association (FNMA), and Freddie Mac, the Federal Home Loan Mortgage Corporation (FHLMC), are both government-sponsored entities (GSEs). It’s a little confusing, but it basically means that though both are private, for-profit companies with their own shareholders. Both were also created by the U.S. government to influence the market.
They enjoy certain perks with this status. For example, they do not pay state or federal taxes (just taxes on real estate). Both Fannie Mae and Freddie Mac were also bailed out by the federal government after the housing crisis in 2008, with the U.S. Treasury purchasing billions in stocks of each company.
What the GSEs do
Clearly, if the government spent billions on bailing Fannie and Freddie out, they must be pretty important -- and they are. The two GSEs play a pivotal part in both mortgage availability and affordability.
What do they do exactly? Put simply: They provide liquidity to the mortgage market. Here’s how that works:
- Banks and lenders issue conventional mortgage loans to consumers. These loans must adhere to the standards set out by Fannie Mae and Freddie Mac (certain property types, borrower qualifications, etc.).
- Fannie Mae and Freddie Mac buy those loans from the lenders. A lender can then use the funds from the sale to keep issuing more mortgage loans.
- The GSEs then bundle those purchased loans into pools of mortgage-backed securities and sell them to investors. This is called the secondary mortgage market.
- The GSEs then have more cash to buy additional loans, and the circle continues.
The whole point is to keep money flowing into the mortgage market. And when there’s more money (supply), it means lower rates and costs for everyone.
Types of loans they buy
Fannie Mae and Freddie Mac both purchase conventional, conforming loans -- which are loans that fall under the conforming loan limit. That limit changes annually, but as of 2021, it sits at $548,250 in most parts of the country.
To be clear: The companies don’t actually issue conventional, conforming loans. Instead, they set the standards for these loans and then buy them from lenders to provide liquidity. The standards vary by specific loan product, but they typically include a 620 credit score, a 45% debt-to-income ratio or less, and a 3% down payment.
These standards might sound strict, but that’s because the companies are trying to reduce their credit risk. Investors won’t buy pools of loans that have a high risk of defaulting. And in order to put money back into the market for further lending, Fannie and Freddie need those investors to buy up. Therefore, they focus on loan products aimed at good-credit borrowers who are more likely to repay their debts.
Both Fannie Mae and Freddie Mac serve a similar goal, but the two aren’t identical, in history or in execution. Fannie Mae was created first, decades before the idea of Freddie Mac was even on the radar.
The company was founded by Congress in 1938, not long after the Great Depression. At this time, it purchased FHA loans only and functioned on a government budget until 1968, when it became a private, shareholder-owned corporation. Shortly after, Fannie Mae pivoted to purchasing conventional loans, which it still does to this day.
In 2008, after the financial crisis and housing crash, the Federal Housing Finance Agency put Fannie Mae into conservatorship, purchasing 79.9% of its senior preferred stock. Though the company is still in a conservatorship as of now, that status is currently being challenged in court by both Fannie and Freddie shareholders.
Freddie Mac wasn’t started until 1970, when the U.S. government recognized that Fannie Mae needed some competition. Giving Fannie competition -- as in any industry -- would help keep prices down and make mortgages more affordable.
While Freddie Mac also purchases conforming, conventional loans, the company tends to purchase more from smaller lenders and banks than Fannie does. This helps provide even more liquidity to the mortgage market and keeps smaller institutions well-funded for lending.
Overall, Freddie Mac enjoys the same treatment as Fannie Mae. The government placed it into conservatorship in 2008, and the company is exempt from most taxes just the same.
Fannie Mae vs. Freddie Mac: similarities and differences
Fannie Mae and Freddie Mac are very similar, at least where it counts. They both purchase conforming, conventional loans, and they both help provide liquidity to the mortgage market. Both were also created by the U.S. government and later placed into a conservatorship following the financial crisis in 2008.
Still, the companies do have a few key disparities. First, Fannie Mae tends to purchase loans from larger lenders and big-name banks. Freddie Mac focuses more on smaller banks and lenders, like savings banks and credit unions.
Both Fannie and Freddie have their own unique loan products, too. At Fannie Mae, there are 12 different loan products to choose from, including ones for renovating a home, refinancing, or making energy-efficient home improvements. Freddie Mac, on the other hand, has over 20 loan programs. Both companies offer 3%-down loans.