What's the Difference Between Fannie Mae and Freddie Mac Mortgages?
Whether you’re starting the process of mortgage shopping in your quest for a new home or you’ve watched your fair share of news reports about the economy, you've likely heard of Freddie Mac and Fannie Mae. Their names don’t give away too much, though, so what exactly are these financial entities, why were they created and what’s the difference between them?
While neither Fannie Mae or Freddie Mac directly loan mortgage money to borrowers, they serve an important role in working with banks that do. We'll break down everything you need to know about both of these enterprises and the differences in mortgages that each one of them backs.
What Are Fannie Mae and Freddie Mac?
While Fannie Mae and Freddie Mac are different entities, they were both created by Congress to help stabilize the U.S. housing market while it was suffering the economic effects of the Great Depression. The idea behind both was to help ensure that there would always be enough affordable liquidity (funding) for the many banks and other mortgage lending companies across the company to lend to borrowers. In essence, these entities were created to help make it easier for borrowers from different financial backgrounds to obtain mortgages and achieve the dream of home ownership.
Fannie Mae, or the Federal National Mortgage Association, was first established in 1938 after the Great Depression had devastated the finances of borrowers and lenders across the country. In an attempt to help Americans get back on track towards stability, President Franklin D. Roosevelt and Congress chartered Fannie Mae to buy Federal Housing Administration (FHA) mortgages from lenders.
The banks and other lenders could then use the money they received to start offering loans to more borrowers. But what did Fannie Mae do with the mortgages it bought? It bundled them into something called mortgage-backed securities (MBS) and sold them to investors like hedge funds, pensions and even individual investors.
When investors bought into an MBS, they essentially bought parts of the loans themselves, which allowed the investors to profit in much the same way that mortgage lenders did from interest payments. The upside, of course, was that they were able to enjoy payments from loans that had already been extended to borrowers by other financial institutions.
Fannie Mae Goes Public and Freddie Mac Emerges
Fannie Mae was funded by Congress until 1968, when the government needed the growing amount of money it had been diverting to Fannie Mae to fund the Vietnam War instead. At that point, the government allowed Fannie Mae to become a publicly traded company and begin selling shares on the stock market.
Even though the government largely stepped out of the picture as investors began purchasing shares, it still backed Fannie Mae as a company, which meant that all of Fannie Mae’s loans were guaranteed by the government. At this point, Fannie Mae was no longer limited to FHA-backed mortgages but became free to buy other types of mortgages as well.
Freddie Mac — officially known as the Federal Home Loan Mortgage Corporation — came into existence in 1970, when Congress created it under the Emergency Home Finance Act. The concept was similar to that of Fannie Mae, in that it, too, bought mortgages from lenders so that the lenders could make more loans.
In part, Freddie Mac was created to expand the secondary mortgage market, but it was also meant to keep Fannie Mae from becoming a monopoly. In 1989, Freddie Mac also went public and became a shareholder-owned company under a Congressional charter.
The main difference between the two entities is that Fannie Mae focuses on purchasing mortgages from large retail or commercial banks, while Freddie Mac buys them from smaller community banks or savings-and-loan associations. While they both exist to make home-buying more accessible to a wider range of borrowers and to provide stability in the lending market, the mortgage loans they purchase come from different sources. Fannie Mae and Freddie Mac also offer different programs to people who can only afford to make lower down payments.
The Great Recession Hits the U.S. Economy — and Fannie and Freddie
To a large extent, the idea behind Fannie Mae and Freddie Mac did a lot of good when it came to the U.S. housing market and the goal of improving access to loans for borrowers who didn’t meet traditional mortgage requirements. However, the problem, some argued, was that even though neither entity was necessarily a monopoly, the combination of the two became one. The fact that they're allowed to borrow money from the government at a lower rate than almost any other business in the industry has also caused people to argue that these entities have an unfair advantage that's led to the collapse of smaller companies.
By 2009, 90% of all mortgages in the United States were backed by either Fannie Mae, Freddie Mac or the Federal Home Loan Bank System (FHLB) — a group of 11 government-sponsored financial institutions. Banks were hesitant to give out loans without backing from these entities because they carried "an implicit government guarantee," meaning people didn’t think the U.S. government would allow them to fail. Thus, there was a perceived higher level of security and stability to a Fannie- or Freddie-backed loan.
Both companies were thrust into the spotlight during the housing crisis of 2008, when they ended up losing a great deal of money by backing high-risk loans. Because of their close relationship with the government, however, they had literally become "too big to fail" — allowing them to go under could’ve triggered a financial disaster of global proportions.
They ultimately received a massive $191 billion bailout from the government, but not without repercussions. The U.S. Treasury Department now owns $100 billion of their preferred stock and mortgage-backed securities, and they operate under government conservatorship with the Federal Housing Finance Agency (FHFA). All of the profits these shares receive are now deposited into the general treasury.
Additional Differences Between Fannie and Freddie
While there are several key similarities in mortgage loans backed by both Fannie Mae and Freddie Mac, there are also a few differences when it comes to what kind of loans they guarantee. For instance, Fannie Mae backs a HomeReady loan, which requires the borrower to have an income that's no more than the 80% average in the area they live in. It also offers a Standard 97% loan, however, that doesn't have any income restrictions but is intended for first-time buyers.
Freddie Mac's Home Possible loan, on the other hand, is available to those with a maximum 100% median area income or those who plan to buy in "underserved" areas. All borrowers for this type of loan must also live on the property they plan to purchase, whereas Fannie Mae's similar loan only requires the borrower to live in the home if they make a down payment of less than 5%.
The other differences are mostly behind-the-scenes guidelines that deal with different minimum down payments on fixed-rate loans and adjustable-rate mortgages. These differences also include home equity requirements for borrowers who are interested in a cash-out refinance for their primary residence.
Keep in mind that neither Fannie Mae or Freddie Mac actually directly makes loans to lenders. Instead, they buy these loans from approved financial institutions. The differences in their programs are important if you’re interested in borrowing from a lender that’s backed by one or the other. Finding a lender that’s backed by one of these two programs can have advantages, as neither tends to do business with unreliable lenders that might attempt to take advantage of their customers.