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Why Are Fannie Mae & Freddie Mac Important - Real Estate Tips

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Published on Aug 3, 2013

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If you've remotely watched or read any news since 2008, you've probably heard bits and pieces about Fannie Mae & Freddie Mac. And if you're one of those people that have heard bits & pieces about them, you might not know exactly what they do. Both Fannie Mae & Freddie Mac are government sponsored enterprises, or GSE. Fannie and Freddie actually played -- and still play -- a key role in obtaining an affordable home mortgage.

We have to start with how a loan is started first -- at a bank. What typically happens is a person walks into the bank and requests a loan to buy a house. The banks of course are glad to oblige, so long as the borrower can qualify financially. Of course for their work, a bank is going to charge a fee to do your loan and make sure the home seller gets their funds.

Now, what the bank has is a note saying they will receive monthly payments from that borrow over 30 years. Lets say the mortgage is $1000/month for a $200k loan. The banks are going to hold on to this loan, and over time, that same $200k will be worth almost $360k. Not a bad profit right?? However...another homebuyer...and then another and another...all these customers come in wanting a loan for a new house. Banks however have a rule. They must keep a certain dollar amount balance in their possession. If this bank has $10m, and they continuously give away $200k loans to perfectly qualified buyers at a rate of one loan a day, they will have ZERO dollars after 50 days...not even two months.

But these banks WANT your business...not only can they make a percentage on your loan, they can make fees each time they do one! ...So how do they keep business flowing?? This is exactly where Fannie & Freddie come in. To simplify all the details, the bank SELLS the $200k note to Fannie & Freddie. These 2 huge government sponsored companies don't necessarily care about keeping that particular dollar amount balance like a bank has to. They live perfectly comfortable with the $1000 payments over time.

Fannie & Freddie pays for the $200k note, and the bank gets to keep all the fees from setting up the loan. Fannie & Freddie get to keep all the $1000 monthly incomes, the bank gets more money to give to new customers, and new customers are able to buy a home. Fannie & Freddie's main goal was to keep that dollar balance in check with banks so that they could continue to give loans to buyers ...Could you imagine walking into a bank to get a home loan and they say "No" because they cant afford it? What if EVERY bank said that? What would happen to the housing market??

This circle of money has been going on for decades. However, there was a problem that happened recently. Fannie & Freddie got lazy. Again to simplify the problem, since banks sell these loans to Fannie & Freddie, guess who makes the rules on what a "qualified" borrower is? That's right -- Fannie and Freddie. And what happened during the 2000's was that Fannie and Freddie kept bending their rules about who was "qualified"...before you needed good credit...during the 2000's...eh, not that big a deal...before you needed to have 3 or 5% down...during the 2000's...of course you could do no down payment!! Before you needed to have a stable job and income...during that timeframe, you could just say you made whatever you wanted and they wouldn't even look twice.

Therefore, these two giant companies that were expecting millions of people to pay their mortgages got a RUDE awakening when people stopped paying...now that $200k note that would've been worth $1000/month over 30 years was worth zero...and so was the next one...and the next one...and millions of others.

Now at this moment, some government officials want to completely dismantle Fannie & Freddie. The National Association of Realtors along with other government officials are saying "No no no, let's fix things". And this is what's causing people to look at Fannie & Freddie more closely. How did two government sponsored enterprises with over $4 TRILLION in assets mess up so badly?? So what's the future for Fannie & Freddie? Nobody really knows yet. What's likely to happen is that they won't be completely stopped and shut down. I would personally imagine they reform the structure of it so huge mistakes like this aren't made again and that some checks and balances be put in to oversee everything is constantly running smoothly.

Whatever the outcome, it's going to have an effect on you if you're trying to buy or refinance your home...now that's good to know.

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