Advice Center

Where Mortgage Money Comes From

Things have changed remarkably since those days. Most of the money for home loans now comes from three major institutions:

• Federal National Mortgage Association (FNMA or "Fannie Mae")
• Government National Mortgage Association (GNMA or "Ginnie Mae")
• Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac")

Federal National Mortgage Association – Though a private corporation, Fannie Mae is loosely supervised by the U.S. Department of Housing and Urban Development (HUD). Congress originally created Fannie Mae as a government agency in 1938 as a way to raise funds for the home loan program of the newly created Federal Housing Administration (FHA)

Today, Fannie Mae raises money for all three primary types of loans (FHA-insured loans, conventional loans, and loans guaranteed by the Department of Veterans Affairs) by buying loans that already have been made. It gets the money for these purchases from the sales of bonds to investors. These bonds are a relatively safe investment because they are backed by the real estate upon which the mortgages were made. If the borrower under a loan purchased by Fannie Mae fails to pay, the property is foreclosed and sold so that Fannie Mae can recover its investors' money. 

Government National Mortgage Association – An agency of the federal government under the control of HUD. Created in 1968 when Congress privatized Fannie Mae, Ginnie Mae operates similarly to Fannie Mae, except that it does not buy conventional loans. In addition to creating a secondary market for government-guaranteed loans, it also directly makes low-interest loans for urban development and for housing projects in low-income areas.

Federal Home Loan Mortgage Corporation – Another private corporation created by Congress (under the auspices of HUD) to help provide money for home loans by selling mortgages on the secondary market. Congress formed Freddie Mac in 1970 as a way to help banks and savings and loan associations by creating a secondary market for their loans. (At the same time, Congress gave Fannie Mae the same authority.) Freddie Mac primarily buys conventional loans, but may also buy FHA and VA loans. Freddie Mac raises money for loan purchases through the sale of "mortgage participation certificates" and "guaranteed mortgage certificates."

How the process works

Here, in a very small nutshell, is a simplified overview of how the process involving the above institutions works.

Assume that a bank in Iowa has exactly $200,000 to loan, and not a penny more. A mortgage broker in Oregon City knows of the money that the Iowa bank has available to loan, and tells a home buyer about the excellent interest rate that the Iowa bank is offering.

The home buyer decides to accept the terms being offered on the loan, submits an application to the broker, and locks in the interest rate. The mortgage broker processes the loan for the Iowa bank, and the sale closes when the bank pays out the $200,000. Its loan money now gone, the bank can make no more loans until it receives more deposits. Or can it?

Enter Freddie Mac! With money from mortgage participation certificates it recently sold, Freddie Mac buys the loan from the Iowa bank at face value, or $200,000. The bank signs over the loan note to Freddie Mac, which now begins collecting the loan payments. The bank then takes the $200,000 it just got from Freddie Mac and goes off to make another loan.

While it's relatively easy to see in this example how Freddie Mac could make money for its investors (collecting the interest that accrues in the loan payments), some people will wonder how the bank can make any money doing business this way. How does it make any profit if it's always making and selling loans for equal amounts? The answer to this is easy too:  it makes its money off the loan fees it charges.

Of course, this process of buying and selling loans would be cumbersome and time-consuming if these big three secondary market makers approached each lender individually about each and every loan that was made. To streamline the process, and reduce risk to investors, each of these institutions has developed specific standards that apply to the loans that it buys; and each institution only buys loans in packages, or "pools," that conform to these standards. The standards relate to such things as maximum loan amounts, property condition requirements, borrower qualification requirements and so on. 

Once an institution like Fannie Mae purchases a pool of loans, it usually pays a small fee to another company, called a "loan servicer," to collect the payments for the loans. The loan servicer then forwards the funds it collects to the institution so that the institution can repay the investors who bought the institution's bonds.

Thus proceeds a repeating cycle that produces most of the cash for mortgage lending.

Banks that buy loans

Now we always hear stories about how loans are continually sold and resold from one bank or mortgage company to another. Everyone is bound to have heard of a friend or relative who got a home loan, then had the loan sold several times, often in the first few years of the loan.

In fact, what happens most of the time is that the home loan was sold only once, as part of a pool to Fannie Mae, Ginnie Mae or Freddie Mac. Subsequently, the servicing of the loan (collection of payments) was sold to another company, then later to another company, and so on. Just like loans themselves can be sold, so can the servicing of loans.

Of course, there are banks and other mortgage companies that make loans without selling them. And the big three institutions aren't the only entities out there buying loans. Sometimes banks do buy loans, but these loans that lenders hold onto are typically sub-prime loans (riskier, high-interest loans), unusually large residential loans, or large commercial loans. These are loans that the government-chartered institutions refuse to buy because there is greater risk associated with them.

These higher-risk loans may also be packaged into different kinds of pools for smaller investors who specialize in buying high-risk loans. Just as with loans from the government-chartered institutions, these investors may even back their purchases with sales of bonds or similar securities.

"Mortgage banking" is the term often used to refer to this buying and selling of mortgages and mortgage-backed securities. Mortgage banking is the proverbial backbone of the mortgage business.