Fannie Mae: What It Does and How It Operates (2024)

There's a very good chance you've heard of Fannie Mae. But do you know what it does and how it operates?

The Federal National Mortgage Association (FNMA), better known as Fannie Mae, is a government-sponsored enterprise (GSE) founded in 1938 by Congress during the Great Depression. As part of the New Deal, it was established to stimulate the housing market by making more mortgages available to moderate- to low-income borrowers.

Fannie Mae does not extend mortgages to borrowers. But it does purchase and guarantee them through the secondary mortgage market. That reduces the risks to banks, making them more willing to loan money.

In fact, Fannie Mae is one of two of the largest purchasers of mortgages on the secondary market. The other is its sibling, the Federal Home Loan Mortgage Corporation, or Freddie Mac, another government-sponsored enterprise created by Congress.

Fannie Mae's Early Days

In the early 1900s, buying a home was a formidable task for all but the wealthiest.

A hefty down payment was required and the loans were almost always short-term. In modern terminology, they were balloon mortgages requiring a large lump-sum payment at the end of the loan term. The bank would foreclose if the homeowner couldn't make the payment or refinance the loan.

That became even more difficult with the onset of the Great Depression. Annual foreclosure rates rose every year from 1926, the first year figures were kept, until 1934, when the rate peaked at well over 12%.

The United States Congress responded by creating Fannie Mae. The aim was to open up a stream of financing for home purchases, available to even those with modest incomes.

This led to the modern system of long-term, fixed-rate mortgages that could be refinanced at any point during the course of the loan.

In 1968, Fannie Mae began funding itself by selling stock and bonds after the government removed it from the federal budget. Fannie Mae retained its ties to the government as a GSE, with a board of directors comprised of no more than 13 members. It is exempt from local and state taxes.

Creating Liquidity

By investing in the mortgage market, Fannie Mae creates more liquidity for lenders such as banks, thrifts, and credit unions, which in turn allows them to underwrite more mortgages.

The mortgages it purchases and guarantees must meet strict criteria. For example, the limit for a conventional loan for a single-family home in 2023 is $726,200 for most states as well as the District of Columbia and Puerto Rico. For certain states and territories with high housing costs, including Hawaii, Alaska, Guam, and the U.S. Virgin Islands, the limit is set at $1,089,300.

In order to do business with Fannie Mae, a mortgage lender must comply with the Statement on Subprime Lending issued by the federal government. The statement addresses several risks associated with subprime loans, such as low introductory rates followed by higher variable rates; very high limits on how much an interest rate may increase; limited to no income documentation, and product features that make frequent refinancing of the loan likely.

In 2022, Fannie Mae helped 542,740 people buy their own homes for the first time. It helped 2.6 million households buy, refinance, or rent a home. By buying mortgages, it added $648 billion in liquidity to the banking system.

Mortgage-Backed Securities

After purchasing mortgages on the secondary market, Fannie Mae pools them to create packages of mortgage-backed securities (MBS). These securities are purchased as investments primarily by large institutional buyers such as insurance companies, pension funds, and investment banks. Fannie Mae guarantees payments of principal and interest on its MBS.

Fannie Mae also has its own portfolio, commonly referred to as a retained portfolio. This invests in its own mortgage-backed securities as well as those from other institutions. Fannie Mae issues debt called agency debt to fund its retained portfolio.

The Financial Crisis

Fannie Mae has been publicly traded since 1968. It traded on the New York Stock Exchange (NYSE) until 2010 when it was delisted in the midst of the financial crisis after its stock plummeted below the minimum capital requirements mandated by the exchange. It now trades over-the-counter.

Unethical and reckless lending practices led to the financial crisis. During the housing boomof the mid-2000s, lenders lowered their standards and offered home loans to borrowers with little or no prospect of repaying their loans.

In 2007, the housing bubble burst, and hundreds of thousands of these borrowers went into default. Known as the subprime meltdown, this event had a ripple effect on the credit markets, sending the financial markets into a tailspin and creating the most severe recession in decades in the United States.

Government Takeover and Bailout

In the latter half of 2008, Fannie Mae and Freddie Mac were taken over by the government via a conservatorship of the Federal Housing Finance Committee.

At the time, they held a total of $4.9 trillion in bonds and mortgage-backed securities. The U.S. Treasury provided $191.5 billion to keep both solvent.

In essence, the U.S. government intervened in order to restore trust in the markets by promising to bail out bad loans and prevent a further slump in the housing market.

Credit Options

Fannie Mae offers a number of business initiatives and credit options to homeowners, working with lenders to help people who might otherwise have difficulties obtaining financing.

• HomeReady Mortgage: This product allows homeowners to secure financing and purchase a home with a low down payment. Borrowers qualify if they have low to moderate incomes and a credit score below 620. People with scores above 620 get better pricing.
• 3% Down Payment: Another resource for homeowners who may not be able to come up with a large down payment.
• HFA Preferred: This program helps homeowners access affordable financing through local and state Housing Finance Agencies and other lenders. Income levels for borrowers are determined by the HFA, and there are no first-time buyer requirements.
• RefiNow: This is a new refinance option for low-income mortgage holders. The program allows a reduction in the homeowner’s interest rate by a minimum of 50 basis points and a savings of at least $50 in the homeowner’s monthly mortgage payment. In order to be eligible, homeowners must be earning at or below 80% of their area median income (AMI).

A full list of products and their descriptions are available on Fannie Mae's website.

Loan Modifications

Following the mortgage meltdown, Fannie Mae began to focus on loan modifications.

Between the September 2008 meltdown and the end of June 2023, Fannie Mae and Freddie Mac have completed roughly 6.8 million loan modifications to prevent bank foreclosures. The refinancings changed the conditions of existing mortgages to help homeowners in financial trouble to avoid defaulting,

Modifications can include reducing the loan interest rateorextending the term of the loan in order to lower the monthly payments.

The Bottom Line

Fannie Mae has managed to turn itself around since going over the edge in 2008. Today it is the largest backer of 30-year fixed-rate mortgages in the U.S. and remains a key mechanism for facilitating homeownership.