Fannie Mae and Freddie Mac: A Look at Mortgage Lending Without Them

Some legislators say we don’t need mortgage giants Fannie Mae and Freddie Mac. What would happen if lawmakers got their way?

Ever wondered how a home owner's financial situation would be different without a government-backed loan? Image: Comstock Images/Getty Images

Some in Congress want to shut down Fannie Mae and Freddie Mac. They think the government shouldn’t be spending taxpayer money to support the mortgage market and that we should instead rely solely on Wall Street for mortgage market funding.

But that could cost you more than $1,000 a year in higher mortgage interest payments, and make it tough to find a 30-year fixed-rate loan when you want to refinance or buy. After all, Fannie Mae, Freddie Mac, and the FHA guarantee almost 90% of U.S. mortgage loans.
   
We looked at two hypothetical families—the Smiths and the Joneses, who each buy a $200,000 home with a 20% downpayment—and calculated how different their financial picture would be if one family didn’t have a government-backed loan.

Our scenario assumes a 1 percentage point difference in the two families’ loan rates. Some experts believe a 1% difference is conservative and would be even higher in a world without Fannie Mae or Freddie Mac guarantees.

Interest rates

The Jones family’s loan:

  • Fannie Mae-guaranteed 30-year fixed-rate mortgage
  • Interest rate: 3.93%

Their rate is low because the bank making their loan knows Fannie Mae will guarantee the payments if the Joneses get into financial trouble. The Fannie Mae guarantee makes their loan less risky for the bank, so it tells the Joneses they can put down just 5% on their new home. They opt to put down 20%, instead, to avoid PMI.

The Smith family’s loan:

  • Fixed-rate mortgage that isn’t guaranteed by Fannie Mae or Freddie Mac
  • Interest rate: 4.93%.

They don’t have the option of putting down just 5%. Their lender gets its mortgage funding from a Wall Street firm that wants a big downpayment as security against the loan and charges a higher interest rate because there’s no guarantee on the loan.

Monthly payments

Both families finance $160,000. The mortgage payment on the Smith’s 4.93% loan is $852.08 per month. The Joneses’ Fannie Mae loan carries a lower interest rate, so their monthly payment is nearly $100 a month less. In the first year alone, the Joneses save $1,597.47 because of the Fannie Mae guarantee.

  Smiths Joneses
Finance amount $160,000 $160,000
Interest rate 4.93% 3.93%
Monthly payment $852.08 $757.42
Year 1 savings N/A $1,597.47

 

Financial troubles

Five years later, the Smiths and the Joneses both run into financial trouble that makes it hard to pay the mortgage. 

Mrs. Smith is laid off. The Smiths’ bank can’t help them because the Wall Street firm that it sold the loan to refuses to modify their loan.

Mr. Jones has a serious illness, and his treatment creates a large medical bill that isn’t covered by insurance. Because the Joneses have a Fannie Mae loan, their lender is required to follow a different set of rules about borrowers with financial difficulties. Their lender offers a reduced monthly payment until Mr. Jones is back on his feet. They will have to make up the difference once they’re caught up on the bills.

Fortunately, Mrs. Smith quickly finds another job and the Joneses inherit money from a long-lost uncle and pay off their medical bills. Both families get caught up on their loan payments.

Refinancing

Ten years later, the Smiths and the Joneses want to send their oldest child to college. Their homes have appreciated nicely, so they want to refinance their mortgages and use their home equity to pay the tuition. 

The Smiths call their lender and find out the Wall Street firm that bought their loan 10 years ago is no longer buying loans in their market because investors don’t like the foreclosure rate in that city. 

They have a hard time finding a lender willing to help them and after a time-consuming search, they find an adjustable-rate mortgage from a local bank. This makes them nervous: Rates will inevitably rise and their mortgage costs will go up.

The Joneses are able to refinance into a 15-year loan backed by Fannie Mae or Freddie Mac, which guarantees loans in all markets and whether home values are rising or falling.

Loan payoff

When they get to the closing table to sign the paperwork for their refinanced mortgage loans, the Smiths and the Joneses see two very different sets of numbers because of the different interest rates they were charged over the past 15 years.

Interest paid. The 3.93% rate on the Joneses’ Fannie Mae loan meant they paid $78,882.27 in interest over 15 years, while the Smiths paid $101,177.31—that’s $22,295.04 more. 

Principal paid.
 The two families also repaid different amounts of principal. The Jones’ paid off more of their principal—$57,115.30—while the Smiths repaid only $51,752 of their note because their interest rate was higher.

Amount owed. That higher interest rate also affects how much they still owe on their original mortgage. While the Smiths have to refinance $108,884.70, the Joneses only have $103,303.80 left to pay off—all because Fannie Mae’s guarantee gave them a lower interest rate.