Troubles with Freddie, Fannie Affect Mortgage Rates

The nation's two largest mortgage institutions recently stepped close to the brink of collapse and bankruptcy, sending shock waves through the nation's economy. These problems can impact mortgage rates, which is important to those buying or refinancing a home.

Fannie Mae, the Federal National Mortgage Association, and Freddie Mac, the Federal Home Loan Corporation, handle about half of all the mortgages in the U.S. Their purpose is to ensure an ample supply of mortgage capital so that Americans can borrow at affordable mortgage rates to buy and refinance homes.

These two agencies help to minimize risk related to mortgage investment by offering an implied promise that they'll have the full backing of the United States Treasury to help cover any defaults on loans that they process and then resell to investors. This means that if people stop making their mortgage payments, lenders who supply the cash for those loans by buying them from Fannie and Freddie will still be reasonably compensated.

Affordable mortgage rates

Without that kind of added reassurance, investors would charge higher mortgage rates to help compensate themselves for the added risk. As a result, rates on typical 30-year conventional fixed rate mortgages would climb, making it more expensive to buy or refinance a home. Therefore, it's in the nation's best interest to make sure that Fannie and Freddie remain healthy, so that Americans can participate in the dream of home ownership.

Impact on mortgage rates

During the second week of July, both agencies lost almost all of their value, as their stock prices plunged to the low single digits from last year's levels of around $70 a share. What saved them from total insolvency was emergency reassurance at the highest levels of government. The Federal bank offered unwavering support--with promises to back the institutions with billions of dollars-so that investors wouldn't panic and send the companies into bankruptcy.

The average consumer may not even understand what Fannie Mae and Freddie Mac do, or why they're important, but the main thing to grasp is that such a catastrophic event as their demise would have had a direct impact on mortgage rates. They would have risen a half point to a full point overnight if one or both of the agencies had gone out of business. For the time being, they're still viable, but the next few weeks and months will test their strength and resolve.

The tremors from the Fannie and Freddie drama still reverberate on Wall Street, and confirm the worst fears of many economists who now think that we're headed into a much longer and more severe period of economic pain. Consumers should keep an eye on Fannie and Freddie because, if they fail, mortgage rates will spike and probably remain higher. If Fannie and Freddie recover, however, it will be a positive sign that the mortgage and housing crisis is easing and finally coming to an end.