Here’s a simplified overview of how banks, Fannie Mae, Freddie Mac, and the US government work together in the context of the secondary mortgage market:
The secondary mortgage market operates as follows:
- Mortgage Origination: Banks and other financial institutions originate mortgages by lending money to homebuyers.
- Sale of Mortgages: These banks then sell the mortgages to government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac. This helps the banks free up capital to issue more loans.
- Packaging into MBS: Fannie Mae and Freddie Mac package these mortgages into mortgage-backed securities (MBS), which are then sold to investors. These securities are essentially claims on the principal and interest payments made by the homeowners.
- Guarantee by GSEs: Fannie Mae and Freddie Mac provide a guarantee to the investors that they will receive their principal and interest payments, even if some homeowners default on their loans.
- Government Support: The US government provides a level of support to Fannie Mae and Freddie Mac, ensuring their stability and the ongoing flow of credit in the mortgage market.
- Payments Flow: Homeowners make their mortgage payments to the banks, which then pass these payments on to Fannie Mae and Freddie Mac. These payments are ultimately distributed to the investors who hold the MBS.
This system helps to provide liquidity in the mortgage market, enabling banks to offer more loans to potential homebuyers and promoting stability in the housing market.