Where Your Mortgage Check Ends Up : Thanks to the secondary mortgage market, your mortgage can go halfway around the world and fund still more home loans.
Walton and Helen Monagan, after pulling together a $6,000 down payment, needed a $118,000 mortgage to buy the South-Central Los Angeles home they had rented for 17 years.
Meanwhile, thousands of miles away, a Singapore bank was eager to invest $1 million in U.S. real estate like the home the Monagans wanted to buy.
And in Santa Ana, the Flores family decided last spring to refinance their $170,000 home, replacing the original 10% mortgage with an 8.25% loan.
By coincidence, a London retirement fund looking for a safe but lucrative place to invest some $2 million for its pensioners would happily agree to the 8% interest rate the Flores loan will produce.
Santa Ana is a long way from London, and South-Central L.A. is further still from Singapore. So what are the chances that the American borrowers and the foreign investors might ever link up?
The odds improve considerably when two powerful financial matchmakers known best by their nicknames--Fannie Mae and Freddie Mac--enter the picture.
Fannie Mae (the Federal National Mortgage Assn.) and Freddie Mac (the Federal Home Loan Mortgage Corp.) help millions of home buyers across America obtain loans by tapping into Wall Street and the rest of the world’s capital markets to raise money for mortgages.
Fannie, headquartered in Washington, and Freddie, based in McLean, Va., were created by Congress (Freddie in 1970 and Fannie in 1983), with the nearly identical missions of generating a steady supply of money for home loans at reasonable rates.
The two stockholder-owned companies, which earned $2.6 billion between them last year, are a powerful force in the home mortgage market. Yet despite their key role in putting buyers in houses, the two companies are little-known by the typical borrower.
Here’s who Fannie Mae and Freddie Mac are and how they help home buyers:
The two companies make up a large part of the “secondary” mortgage market, so named because they do not enter the picture until the primary transaction between the home buyer and the “origination lender” is completed.
After the loan is made, Fannie or Freddie may buy the mortgage from the lender. Together, the two companies buy one of every five U.S. mortgages from the origination lenders, which provides the lenders with fresh cash to make more loans. (The remainder of the mortgages are made by S&Ls;, banks and private investors who keep the loans in their portfolios.)
Fannie and Freddie then bundle thousands of the mortgages into tradable securities that are large enough--a $500 million agglomeration of individual loans is common--to attract investors such as U.S. life insurance companies, Japanese pension funds, Swiss money markets or the central bank of Zimbabwe.
The rise of the secondary market, which began in the early 1980s, has benefited consumers in a number of ways. Cheaper mortgage money is chief among them. Most estimates credit the companies with lowering interest charges to borrowers by up to a half of a percentage point.
“We provide liquidity at the best price possible for the homeowner without disruption in the mortgage money supply,” said Fannie Mae president Lawrence M. Small.
But most home buyers are unaware of Fannie and Freddie’s role in their lives.
“We had no idea,” said 25-year-old Marlene Flores when she learned of the part Freddie Mac played in her family’s financial matters. “We just thought the money came from everybody’s savings accounts.”
A decade ago or so, Flores’ assumption would have been right. Up until the early 1980s, most mortgage money came from deposits in savings and loan associations.
Now, though, instead of individual savers making home purchases possible, money merchants on Wall Street or in the world’s other financial centers provide the capital to make home loans. As a result, bits and pieces of American mortgage payments prop up billions and trillions of dollars of financial ventures here and abroad.
It’s easy to understand why most American borrowers have never heard of Fannie Mae or Freddie Mac. When their loan closes, most home buyers or refinancers are told where to send their monthly payments and little more.
In the Flores’ case, for example, Chatsworth-based Great Western Bank continues to administer, or “service,” their mortgage, even though it sold the loan almost immediately to Freddie Mac, said Sam Lyons, a Great Western senior vice president.
“The borrower sees absolutely no difference, because we collect the payments and all contact is with us,” Lyons said.
Marlene Flores, though, is more concerned with her family’s part in scheme of things. “It does not matter who lends the money,” she said. “What is important is that we manage to make the payments every month.”
Walton Monagan, a truck driver who bought his long-time rental home with his wife, Helen, an in-home care provider, was nonchalant when told that of Fannie Mae’s role in his home purchase. “It doesn’t bother me,” he said. “As long as I pay my note, they can [take my check] and pay it to the moon if they want.”
The Flores’ Mortgage
The Flores loan is following a typical course through the secondary market.
On May 2, 1994, two generations of Flores signed the papers with Great Western for a $98,400 mortgage to refinance their four-bedroom Santa Ana home of five years. The mortgage was taken out in the names of the parents, Antonio, a retired construction worker, and Celia, a housekeeper, and their adult daughter Marlene, a mail carrier. Also living in the family home are Antonio Jr., 21, Lucelia, 20, and Alvaro, 13.
Eight days later, Great Western sold the Flores loan to Freddie Mac, along with three others loans in the 8.25% range that it had made on Southern California homes.
A month later, the four California mortgages were absorbed into a $313-million mortgage pool of home loans assembled by Freddie Mac from throughout the country.
Looked at another way, the Flores mortgage accounted for 3/10,000ths of the $313-million mortgage pool, said Karen Eckert, Freddie Mac senior financial systems analyst.
All the loans in the pool were put up for sale by lenders at around the same time, meet the same borrower qualification guidelines and bear interest rates close to 8.25%.
The investors, however, are buying an 8% yield. The lender and Freddie Mac both get cuts for the roles they play in the process. The return on the security is further dictated by what the investors paid for it and the length of time the investors will receive payments.
In June, the original investors spun off parts of the $313-million security into a $102-million pool and a $30.4-million pool.
Soon thereafter, parts of the Flores loan became building blocks for six more investment pools. One receives the interest-only part of the mortgage payments, another draws the principle only and the rest collect principle and interest in varying proportions for various periods of time.
About $488 of the Flores $740 monthly payment goes to the first investor rung. Next, in separate payouts, $33, $103, $44, $7, $89 and $118 go to a spectrum of second-tier investors. Then, some of those payment portions filter down into two more trades.
The chain reaction continues only six months later, at the end of October, the $98,400 Flores loan has already been securitized and re-securitized into 98 investment products with a combined value of a little more than $3 billion, Eckert said.
There are so many opportunities to mix things up that the results could get a little strange.
In theory, at least, “a borrower could end up owning part of his own mortgage if he has put some of his savings into a pension fund or a 401K plan,” said Stephen Hopkins, Freddie Mac’s national sales director.
The Monagans’ Loan
In sharp contract to the Flores mortgage, the Monagans’ loan has made one of the simplest journeys, at least for now.
When Fannie Mae bought the loan in May along with scores more with the same 7.625% interest rate, company officials decided to hang on to it rather than offer it for sale as part of a security, although it could sell it at a later point.
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FROM YOUR STREET TO WALL STREET
1) After home buyers take out mortgages at local banks or lenders, many loans are sold in the secondary market to agencies such as Fannie Mae or Freddie Mac, providing new money to make still more loans.
2) Fannie and Freddie bundle thousands of these mortgages into tradable securities large enough to attract Wall Street investors.
3) These mortgage-backed securities are sold worldwide to buyers such as U.S. life insurance companies. European pension funds, Asian banks. The local lender and Fannie and Freddie all get cuts for the roles they play in the process.
