The Federal National Mortgage Association (FNMA), more commonly known as "Fannie Mae," is not a bank, nor is it a lending institution in the more common sense of the word. Fannie Mae isn’t a lot of things people believe it to be. What it is, in fact, is a government-sponsored enterprise (GSE) and has been publicly traded since 1968.
Its main function is to purchase both residential and commercial mortgage loans that were previously underwritten by lending institutions, according to established Fannie Mae guidelines. As in the past, this continues to allow those banks to write loans, then immediately sell them to a secondary mortgage market to free up capital in order to make more loans. It’s the circle of life if you’re in the conforming mortgage loan business.
While Fannie Mae doesn’t make loans directly, it does establish the criteria by which a conventional mortgage is written, since these are the mortgage loans directly purchased by the entity. Banks are largely interested in off-loading their mortgages and reducing their exposure to the whims of the housing market, and Fannie Mae gives them a way to do that.
Fannie Mae and commercial lending
Although Fannie Mae was initially designed to help banks, it has accidentally created a huge feedback loop that resulted in more affordable housing for the average homeowner, making it easier to obtain housing financing from any given mortgage servicer. This is great for homebuyers, but Fannie Mae also purchases some types of commercial mortgages.
For example, if a homebuyer is looking to purchase a multifamily property with fewer than five units, this structure can qualify as a home purchase if the buyer occupies one of those units. This is one way that Fannie Mae supports multifamily purchases. But it’s not the only one.
Fannie Mae’s commercial lending standards apply to residential purchases of five or more units, as well, allowing those loans to be purchased by the giant. In a way, this also can contribute to affordable rental housing, since mortgage rates for loans that are able to be purchased by Fannie Mae tend to trend lower than those held by banks in their own commercial lending departments.
Fannie Mae and financial markets
Fannie Mae is vital to supporting commercial real estate investors with mortgages that are attainable and affordable, especially when they’re first getting into the game, but it plays another crucial role in real estate investing. Fannie Mae, along with the Government National Mortgage Association (Ginnie Mae) and Federal Home Loan Mortgage Corporation (Freddie Mac), issue many of the mortgage-backed securities in the market, built from the mortgages they purchase.
These investment vehicles can be solid choices for people interested in putting money into the real estate market without taking much in the way of risk. In their most basic form, known as a pass-through participation certificate, mortgage-backed securities give the holder a share of the principal and interest payments made to a pool of loans that are combined to make the certificate. By combining mortgages, the risk of loss is reduced dramatically, since any single loan failure is buffered by all the loans that are succeeding.
There are, of course, risks to these investments, despite their collateralization. Beyond foreclosures, which represent a total failure of a loan instrument, prepayments can reduce returns since the holder paying off the loan represents the end of interest payments. Because mortgage holders often refinance when loans are cheaper to make, the timing tends to result in holders of mortgage-backed securities being left with money to invest at the worst possible time if they want to remain in the same vehicle.
The Millionacres bottom line
If you pulled back the curtains on the mortgage industry, Fannie Mae would be one of the most crucial components to the inner workings you’d expose. Not only does it buy residential mortgages for up to four units, as well as commercial mortgages, it often turns them into mortgage backed securities that are later sold as investments to individual investors looking to get into stable real estate investments.
It’s safe to say that without Fannie Mae, the mortgage market would be a very different place today.