Your Home Mortgage. How unseen investors generate funds to keep home loans flowing
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``In the past, lending institutions could only lend the money on hand,'' says John Savacool, director of real estate and construction services at Chase Econometrics, a consulting firm. ``And if they ran out of money, they couldn't lend any more.''Skip to next paragraph
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During the 1930s, a lot of people were unable to buy homes because the banks simply did not have the money to lend; nobody else did, either. In the 1970s, the problem returned, though on a much smaller scale, when people took their savings out of banks and similar savings institutions and moved them to higher-yielding money-market mutual funds.
At the same time, if the banks or savings-and-loans kept all the home mortgages they wrote in their own loan portfolios, they were subject to the vagaries of changing interest rates in the open market. If rates rose, many of their depositors would withdraw money from the bank to make more profitable investments elsewhere. Meanwhile, the bank's income-producing assests, the mortgages, shrank as inflation whittled down the value of the incoming monthly payments from borrowers. Birth of the secondary market THE secondary market was born in 1938 when Congress created the Federal National Mortgage Association, or ``Fannie Mae.'' It was empowered to purchase government-guaranteed mortgages from banks, savings-and-loans, and mortgage companies. Fannie Mae gets the money to buy these loans through various types of debt offerings, known as ``mortgage-backed securities.''
After a bank, S&L, mortgage company, or other ``mortgage originator'' has written enough home mortgages, it puts them together in a ``pool'' that it sells to Fannie Mae. With the money it gets from Fannie Mae, the bank can write more mortgages.
Because of the volume of home loans in its portfolio (over $95 billion, making it the largest holder of mortgage securities in the US), Fannie Mae has been able to pretty much set the standard for home loans. The loan application you fill out, and the process the bank uses to approve your loan, are based on Fannie Mae's standards.
This way, investors who purchase securities issued by Fannie Mae don't have to worry that some homeowners won't be able to repay their loans. If there is a problem, they know Fannie Mae will back it up.
That's the simple explanation of the secondary market.
In recent years, the market has become vastly more complicated. In 1968, the Government National Mortgage Association, or ``Ginnie Mae,'' was spun off from Fannie Mae. Two years later, Ginnie Mae introduced the ``pass-through security.'' With this instrument, monthly loan payments are passed from the homeowner, through the lending institution, to the investor. This security consists of a package of residential loans insured by the Federal Housing Administration (FHA) or guaranteed by the Veterans Administration (VA); the security backed by the home loans can be traded like a corporate stock certificate.
Since the early 1980s, these securities have been purchased by thousands of investors in the US and abroad.
In April, Ginnie Mae announced that because so many people had been buying homes or refinancing old, high-interest mortgages into cheaper loans, it had reached its legal limit of $65.3 billion for guaranteeing mortgages. Because so few people ever default on their home loans, very little of this money is actually spent, but these agencies are still required to stay within their mortgage-backing limits.
In May, President Reagan signed a bill raising Ginnie Mae's limit by $60.7 billion more. The Federal Housing Administration, which also hit its ceiling in April, was given $17 billion more to insure home loans.
Another agency, the Federal Home Loan Mortgage Corporation, or ``Freddie Mac,'' was established in 1970. The next year, it began selling securities known as ``mortgage participation certificates,'' or PCs, backed by conventional loans (that is, they are not FHA-insured or VA-guaranteed). These constitute more than 70 percent of all mortgages.