After March 31, The Fed has announced that it will stop buying mortgage backed securities from both Fannie Mae and Freddie Mac, which will in turn possibly cause interest rates on home loans to rise.
Last year, as a result of the of the mortgage crisis and as a result of the Government takeover of two of the largest companies in the secondary mortgage market, The Federal Reserve began purchasing mortgage backed securities from Fannie Mae and Freddie Mac in order to keep the secondary mortgage market liquid so that lenders could continue to issue loans. The Fed purchasing these mortgage backed securities was a way to keep interest rates low so that demand for purchasing houses would increase and continue to remain high. However, as of March 31st, the Fed will no longer continue to purchase these mortgage backed securities from Fannie Mae and Freddie Mac, which means it will make it harder for lenders to issue loans and sell them into the secondary mortgage market. There is a good possibility that this will drive interest rates on home loans up. To better understand this, it might be helpful for me to briefly explain how the secondary mortgage market works, and how it affects interest rates. I will also explain what mortgage backed securities are. Once you get an understanding of these concepts, you will better understand the Dramatic effect that could take place once the fed stops purchasing mortgage backed securties from Fannie Mae and Freddie Mac on March 31st.
When a lender makes a home loan to a customer, it is rare that the lender keeps that loan in their own portfolio. Usually what happens is first the local lender makes a loan to Suzie Homeowner. This lender is part of what is called the primary mortgage market. After this lender who is involved in the primary mortgage market, issues the loan to Suzie Homeowner, that lender sells the loan off to another company who is involved in the secondary mortgage market, such as Fannie Mae. This system is good for lenders in the primary mortgage market, because they make the fees off of initiating the loans, and then they sell the loan to a company in the secondary mortgage market, and the bank who initially made the loan gets their cash back so that it can make more loans to other customers and in turn make more money on loan fees. So you see, the banks in the primary mortgage market make a lot of their money on the fees from initiating the loan, and then they sell the loans to companies in the secondary mortgage market.
The companies in the secondary mortgage market buy hundreds, thousands and even millions of these home loans from lenders who initiate these loans. The companies in the secondary mortgage market can either hold these loans on their books and earn money on the interest received from the loans, or they can package these loans up and sell them to investors as mortgage backed securities. You are probably asking "what the heck is a mortgage backed security?"
A mortgage backed security is a lot like a share of stock. It is a trading security that is actively traded in the open market in the same way that stock is traded. A share of stock is backed by the value of a company. A mortgage backed security is backed by the value of many mortgages that have been pooled together. Mortgage backed securities are created when companies in the secondary market pool together many mortgages that they own and create securities (called mortgage backed securities) that are backed by the value of these pooled loans. They in turn sell these securities to private investors much like companies sell stock to private investors.
This whole process that starts off with the local lender making a loan to Suzie Homeowner, and that ends with investors buying mortgage backed securities, is what enables banks to continue making loans at affordable interest rates.
However, in 2008, Fannie Mae and Freddie Mac ( the two biggest companies in the secondary mortgage market) began having bad problems because many of the loans that they purchased from lenders in the primary mortgage market, began to default. These bad loans made it so investors stopped buying mortgage backed securities from Fannie Mae and Freddie Mac. This eventually led to Fannie Mae and Freddie Mac ending up on the brink of failure, which led to the government taking them over.
The government believed that Fannie Mae and Freddie Mac needed to continue. This was because these companies played such a large role in the secondary mortgage market industry. If Fannie Mae and Freddie Mac failed, it would make it much harder for local lenders to make loans and sell them off into the secondary mortgage market. This would mean that local lenders would have to start holding more loans in their own portfolios. This means lenders making loans would have to take more risk, which means they would charge borrowers higher interest rates. These higher interest rates would reduce demand for purchasing houses, which would be bad for the economy. At the time this was going on, this could have sent our country into a depression.
To prevent all of this from happening. The government got The Federal Reserve to start buying up Mortgage backed securties from Fannie Mae and Freddie Mac. This in turn enabled Fannie Mae and Freddie Mac to continue to buy mortgages from lenders in the primary mortgage market, which enabled lenders to freely make loans at low interest rates. However, after March 31st, the Fed will not continue to buy mortgage backed securities from Fannie Mae and Freddie Mac.
After March 31st, we will be relying on private investors once again to start purchasing mortgage backed securities from Fannie Mae and Freddie Mac. Some think the private investors will start buying mortgage backed securities again from these companies because lending standards are much higher now, which would make the loans that Fannie and Freddie have in their portfolios, good loans. However, would you buy stock from a company that just emerged from bankruptcy? I would not. It's the same concept.
It is very likely that private investors will be very weary about buying mortgage backed securities from Fannie and Freddie. Again, this will make it harder for lenders who make loans, to sell the loans into the secondary mortgage market. This will drive up interest rates on home loans. Higher interest rates will mean less demand for housing and will possibly lead to a further decrease in home values.
If you are thinking about buying a home. I would find a home as soon as possible and lock in a low interest rate before they go up after March 31st. If you have any questions on this subject, please feel free to email me at email@example.com or give me a call at 850 567-0037