Real Estate Finance: Chapter 12 The Secondary Mortgage Market

Automated Underwriting System

(AUS) Fannie Mae provides two versions of its automated underwriting system, the Desktop Underwriter® and the Desktop Originator®, for lender services and independent mortgage broker-agents respectively. Lenders access Fannie Mae's sophisticated loan analysis system through the software they offer their customers. Desktop Underwriter® is the leading automated underwriting system in the industry and is regularly updated to offer more products to more potential homebuyers.

*Federal Housing Financing Agency

(FHFA) The Federal Housing Finance Agency (FHFA) was established under the Federal Housing Reform Act of 2007 as an independent agency to regulate the government-sponsored entities (GSE) of Fannie Mae, Freddie Mac, and the Federal Home Loan Bank (FHLB). At that point, these enterprises had $5.4 trillion of guaranteed mortgage-backed securities (MBS) and debt outstanding with an 80% market share of all new mortgages. Despite the best efforts of the enterprises to provide liquidity to the conforming mortgage market while raising and maintaining capital, their ability to fulfill their mission deteriorated, raising concern over both safety and soundness issues. On September 6, 2008, Fannie Mae and Freddie Mac were placed into conservatorship. The FHFA will act as conservator until the enterprises have stabilized. The U.S. Department of the Treasury agreed to provide up to $100 billion of capital to ensure liquidity in the housing and mortgage markets. The stated goal is to restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed to instability in the market. Under the conservatorship both entities will operate their business as usual but with stronger backing for the holders of MBS and other debt. The FHFA will assume the power of the board of directors and management. Common stock and preferred stock dividends will be eliminated, but all common and preferred stock will remain outstanding.

Government Sponsored Enterprise

(GSE) Fannie Mae and Freddie Mac

Fannie Mae Mortgage-Backed Securities

(MBSs) When Fannie Mae purchases mortgage loans from mortgage companies, savings institutions, credit unions, or commercial banks, they are generally packaged into mortgage-backed securities (MBS) and sold in international capital markets. In June of 2005, Fannie Mae announced that first lien, fixed-rate (and some adjustable-rate) mortgages for a term of up to 40 years would be eligible for inclusion in its MBS pools. Fannie Mae also issued a variety of short- and long-term debt securities to meet investor needs. The Universal Debt Facility Offering Circular is a legal document that provides detailed information on all of Fannie Mae's funding programs. The majority of Fannie Mae's short-term funding needs are met through either Discount Notes or Benchmark Bills. For more detailed information, see "Understanding Fannie Mae Debt" at www.fanniemae.com

Real Estate Mortgage Investment Conduits

(REMICs)

Jumbo Loans

A loan that exceeds the current conforming limits.

*Fannie Mae

A private shareholder-owned company whose stock is traded on the New York Stock Exchange and is also part of Standard and Poor's 500 Composite Stock Price Index. Fannie Mae was established by congressional charter in 1938 as the Federal National Mortgage Association (FNMA) to expand the flow of available mortgage money throughout the country by creating a secondary market for the purchase of FHA-insured mortgages. The scope of operations was broadened in 1944 to include purchasing DVA-guaranteed loans. The purchase of the FHA and DVA loans was made at par; that is, at full face value, making Fannie Mae as sought after provider for the real estate mortgage market.

Secondary Mortgage Market

Consumers <-1- Banks/Thrifts/Mutual Savings Banks -2-> <-5- Fannie Mae/Freddie Mac/FHLB -3-> <-4- Mortgage-Backed Securities Step 1: Primary market lenders (banks, thrifts, mutual savings banks, etc.) provide mortgages to consumers. Step 2: Primary market lenders sell loan packages to Fannie Mae, Freddie Mac, and Federal Home Loan Bank. Step 3: Fannie Mae, Freddie Mac, and FHLB sell mortgage-backed securities on the open market. Step 4: Monies received through the sale of mortgage-backed securities provide Fannie Mae, Freddie Mac, an FHLB with funds to purchase more loan packages from the primary lenders. Step 5: By purchasing more loan packages, Fannie Mae, Freddie Mac, and FHLB provide the primary market lenders with additional money to fund more mortgage loans for consumers.

Desktop Originator®

Electronic loan processing.

Fannie Mae Mortgage Loan Products

Fannie Mae offers both fixed and adjustable-rate mortgage loans in a variety of different loan products. For the most current information on mortgage loans eligible for purchase by Fannie Mae visit www.fanniemae.com, or www.efanniemae.com. Fannie Mae also purchases home construction and renovation loans as well as reverse mortgage loan for seniors (both the FHA Home Equity COnversion Mortgage and Fannie Mae Home Keeper®). Fannie Mae's MyCommunityMortgage® loans offer more flexibility in qualifying guidelines and credit history and have special options for teachers, police officers, firefighters, health care workers, and those with disabilities. There are also special loan products for rural housing and Native Americans.

Desktop Underwriter®

Fannie Mae's electronic system for qualifying borrowers.

Underwriting Standards

Freddie Mac generally follows the same conforming loan standards as Fannie Mae: •Maximum loan amounts are set annually for single, duplex, triplex, and fourplex properties. •Any loan with an LTV of more than 80% must carry private mortgage insurance; cost varies according to the percentage of downpayment. •A 20% down payment may be entirely from gift funds; gift funds are also permitted with less than 20% down, but some percentages may be reuqired from the borrower's own funds, depending on the particular loan product. •The seller can contribute up to 3% of the sales price toward borrower's closing costs with 5% down payment, and up to 6% with a 10% down payment. One exception is that Freddie mac only looks at total debt-to-income ratio with no set percentage for housing expense. The amount of down payment and qualifying ratios varies with different loan products.

Electronic Underwriting System

Freddie Mac provides its own electronic underwriting service, called Loan Prospector®, to participating lenders, mortgage insurers, mortgage bankers and brokers, and others in the real estate market. The Loan Prospector® computer program evaluates a borrower's creditworthiness using statistical models and judgemental rules. The credit evaluation indicates the level of underwriting and documentation necessary to determine the investment quality of a loan. It includes the borrower's credit reputation and financial capacity as well as the estimated value of the property. The credit analysis uses information from the loan application and credit searches. The value of the property is derived from statistical models or from a traditional appraisal.

Freddie Mac Loan Products

Freddie Mac purchases both fixed and adjustable-rate loans for a predetermined amount of time from 15-year, 20-year, 30-year, and 40-year terms. Loans may be for the purchase or refinance of owner-occupied single-family dwellings, condominiums, planned unit developments (PUDs), and manufactured homes. Loans are also available for one-unit to four-unit primary residence and investment properties, and single-unit second homes. For a full description of the variety of loan products that can be purchased by Freddie Mac, see www.freddiemac.com.

Organization

Freddie Mac was established with an initial subscription of $100 million from the 12 Federal Home Loan district banks and placed under the direction of three members of the Federal Home Loan Bank Board. Freddie Mac was given the authority to raise additional funds by floating its own securities, which were acked by pools of its own mortgages. Sine 1989, Freddie Mac has become an independent stock company and is the GSE like Fannie Mae. As a major player in the secondary market, Freddie Mac buys mortgages that meet stated guidelines and product standards, packages the loans into MBSs, and sells the securities to investors on Wall Street. As par of the Housing and Economic Recovery Act of 2008, Freddie Mac came under the supervision of the FHFA and in September 2008, was placed in conservatorship along with Fannie Mae.

Loan Prospector®

Freddie Mac's electronic underwriting source.

Empowerment to Sell Mortgages

In 1954 Fannie Mae was rechartered as a national secondary mortgage market clearinghouse to be financed by PRIVATE CAPITAL. Fannie Mae was empowered to SELL its mortgages as well as purchase new FHA and DVA loans. Fannie Mae's purchases were no longer made at par but at whatever discounted price would develop a reasonable rate of return. This profit attitude was consistent with the reorganizational goal of private ownership. Fannie Mae did not have to purchase every mortgage submitted to it, only those mortgages that met its standards for marketability. Fannie Mae imposed its own criteria for acceptance of mortgages submitted for sale, which sometimes created animosity among mortgage originators. It was argued that one federal agency should accept another's standards. Fannie Mae countered with the argument that the FHA and DVA standards for credit and appraisal were MINIMUM standards and insisted that all mortgages submitted to Fannie Mae would have to meet its own standards for quality, yield, and risk. The quality and level of stability of guaranteed and insured loans were raised in order to meet these new requirements. When Fannie Mae PURCHASES mortgages, a servicing agreement is executed allowing the loan originator-seller to act as a collection agent for a specified fee. This fee, a rate of approximately 1/4 to 3/8 of 1% of the mortgage amount, creates a substantial source of income for the originator, depending on the size of its mortgage loan portfolio. Loan originators derive a large portion of their mortgage investment income from origination and collection fees. In many cases, especially with the mortgage bankers who issue the bulk of FHA and DVA loans, the more loans that can be created, the higher the potential profits. Thus, the Fannie Mae secondary mortgage market allows loan originators an opportunity to "roll over" their money. By selling their mortgages, these originators can secure more funds for making additional loans, thereby collecting more origination fees. When Fannie Mae SELLS its mortgages, it does so in open-market transactions in which the purchasers are required to pay current prices for the securities. This confirms the private ownership profit motives of this agency.

Administered Price System

In the past, Fannie Mae's mortgages purchasing procedures had been handled under a free-market-system auction. Lenders offered to sell Fannie Mae their loans at acceptable discounts, with Fannie Mae buying the lowest-priced loans -- those with the deepest discounts. This system has been replaced by an administered price system in which Fannie Mae adjusts its required yields daily in accordance with market factors and its financial needs. Under the administered price system, lenders call a special Fannie Mae rate line to secure current yield quotes and then a separate line to place an order to sell. Lenders may order a mandatory commitment, whereby delivery of loans to Fannie Mae is GUARANTEED, or a standby commitment, in which the lender retains the OPTION to deliver the loans or not, depending on the price at time of delivery.

Underwriting Standards

Lenders wishing to sell their conventional loans to Fannie Mae must subscribe to their guidelines, which are revised from time to tim. These include the following: •Maximum loan amounts are et annually for single, duplex, triplex, and fourplex properties. •Any loan with a loan-to-value (LTV) ratio of more than 80% must carry private mortgage insurance; cost varies according to the amount of down payment. •A 20% down payment may be entirely from gift funds; gift funds are also permitted with less than 20% down, but some percentage may be required from borrowers' own funds, depending on the particular loan product. •The borrowers' debt-to-income ratios must be 28% of their combined total gross monthly income for housing costs including principle, interest, taxes, insurance, and homeowner association fees; 36% of their total monthly debt including housing costs plus other installment debt expenses. These ratios vary according to the type of loan product. •The seller can contribute up to 3% of the sales price toward borrower's closing costs with a 5% down payment, and up to 6% with a 10% down payment. •Fixed-rate and adjustable-rate loans are available for most loan products. •Homebuyer education and counseling is required for frst-time homebuyers obtaining a MyCommunityMortgage® or depending on non-traditional credit.

Ginnie Mae Mortgage-Backed Securities

Mortgage-backed securities are pools of mortgages used as collateral for the issuance of securities, commonly referred to as pass-through certificates, as the principal and interest payments are "passed through to the investor. The interest on the security is lower than the interest rate on the loan to cover the cost of servicing and the guaranty fee. There are two types of Ginnie Mae MBSs available. The Ginnie Mae I MBS requires that all mortgages in the pool be the same type (Ex. single-family) and that the mortgages remain insured or guaranteed by FHA, DVA, RHS, or ONAP with a minimum pool size of $1 million. Payment is made on the 15th of the month. The Ginnie Mae II MBS provides for multiple-issue pools that allow for more geographic dispersal. Higher servicing fees are allowed, and the minimum pool size is $250,000 for multi-lender pools and $1 million for single-lender pools. Payment is made on the 20th of the month to allow time for payments to be consolidated by a central paying agent.

*Ginnie Mae

The Government National Mortgage Corporation was created in 1968 as a government-owned corporation under the direction of the Department of Housing and Urban Development (HUD) to provide financing for special assistance programs and operate the securities pool. Known today as Ginnie Mae. the stated mission is to expand affordable housing in America by linking domestic and global capital markets t the nation's' housing markets. Ginnie Mae does not buy or sell loans or issue MBSs but instead guarantees that investors will receive timely payments of principal and interest on MBSs backed by federally insured (FHA) or guaranteed (DVA) loans. Other eligible loans for Ginnie Mae MBSs include those originated by the Department of Agriculture Rural and Community Housing (RHS) and HUD's Office of Native American Programs (ONAP). Ginnie Mae MBSs are fully modified pass-through securities guaranteed by the full faith and credit of the U.S. government. Regardless of whether the mortgage payment is made, the investor receives the full principal and interest payment.

Reorganization Under HUD

The Housing and Urban Development Act of 1968 changed the Fannie Mae organization once again. Based on its successful operation in preceding years as a quasi-public, profitable corporation, Fannie Mae was reorganized as a fully private corporation. All Treasury-owned stock was redeemed, and a like amount of over-the-counter common stock was offered to the general public. Fannie Mae became a separate, privately owned corporation subject to federal corporate income tax and exempt from state income taxes. It retains the benefit of government "sponsorship," which includes a line of credit with the U.S. Treasury, and is referred to as a government sponsored enterprise (GSE). The 1968 reorganization was meant to enhance Fannie Mae's ability to participate in the secondary market and to encourage new money to enter the real estate mortgage market. Fannie Mae could now purchase mortgages at a premium (in excess of par) and was allowed to expand its own borrowing ability by floating securities backed by specific pools of mortgages in its portfolio. The Emergency Home Finance Act of 1970 gave Fannie Mae the additional authority to purchase mortgages OTHER THAN FHA-insured or DVA-guaranteed loans, mostly conventional loans. This further expanded Fannie Mae's impact on national real estate finance.

Ginnie Mae Platinum Securities

The Platinum Securities allow investors to combine Ginnie Mae MBS pools into a single security and receive a single payment each month rather than separate payments from individual pools. See www.ginniemae.gov for more information on Ginnie Mae programs.

*Freddie Mac

The credit crunch of 1969 and 1970 gave rise to the Emergency Home Finance Act of 1970, which created, among other things, the Federal Home Loan Mortgage Corporation, now known as Freddie Mac. Freddie Mac was organized specifically to provide a secondary mortgage market for the U.S. savings associations and thrifts that are members of the Federal Home Loan Bank System.

Par

The face value of a bond or security.

Intro

The secondary mortgage market is designed to deal in real estate mortgages, buying them from loan originators and selling them to investors or pooling them to enlarge the markets for these types of securities. When mortgages are purchased from primary lenders, also known as loan originators, the money generated acts to replenish the supply necessary for continued lending activities. When mortgages are sold to investors, funds are recirculated naturally from money-rich areas to money-poor areas. The major participants in the secondary mortgage market are Fannie Mae (formerly the Federal National Mortgage Association), Freddie Mac (formerly the Federal home Loan Mortgage Corporations), and Ginnie Mae (formerly the Government National Mortgage Association). The financial market for real estate loans is based on the ability of loan originators to dispose of their new loans as quickly as possible in the secondary market, as they need to replenish funds and strive to manage the interest rate risk that arises from long-term, fixed-rate mortgages. This results in loan originators having to closely follow the loan guidelines established by the secondary market investors. The trend toward selling real estate loans has led to the development of a major new group of investors. Based on the concept of collateralization--the pooling together of homogenous types of mortgages to use as collateral for issuing marketable securities--private companies have emerged to challenge the dominant positions of Fannie Mae and Freddie Mac. Operating as real estate mortgage investment conduits (REMICs), these life insurance companies, pension funds, securities dealers, and other financial institutions are creating new loans for their own portfolios, as well as buying and selling loans from other originators.

Conforming and Nonconforming Loans

The terms CONFORMING and NONCONFORMING are used by lenders to define loans that conform to the Fannie Mae/Freddie Mac qualifying guidelines. Loans that do not meet the conforming guidelines, including maximum loan amount and down payment requirements, are called NONCONFORMING. According to the Housing and Economic Recovery Act of 2008, the national conforming loan limits are to be set annually by FHFA depending on changes in median home prices calculated by FHA over the previous year. They cannot decline from year to year. Two sets of limited loan amounts are provided for first mortgages: general and high-cost area. For example, the 2009 loan limits are as follow: ---------------| ---General--- | --High-Cost*-- Single Unit- | $417,000.00 | $625,5000.00 Duplex------ | $533,850.00 | $800,775.00 Triplex------ | $645,300.00 | $967,950.00 Fourplex---- | $801,950.00 | $1,202,925.00 *These amounts are the maximum that may apply, but they may be lower for a specific area (set at 115% of local median price). These limits are 50% higher in Alaska, Hawaii, Guam, and the U.S. Virgin Islands. Although these are conforming conventional loan limits, buyers may pay any price for a property, making up the difference in cash. Maximum loan limits are established to set a standard for these types of loans so that they become homogeneous packages for securitization in the secondary market. Loans issued in excess of these amounts are nonconforming. They are called jumbo loans and are usually made by lenders for their own investment portfolios.