Revisiting the Net Benefits of Freddie Mac and Fannie Mae
Percent of Loans
Improving Other Mortgage Contract erms
The non-interest effects of the GSEs can be seen in the characteristics of conforming loans relative to jumbo or nonconforming loans. In addition to lower interest rates, conforming loans are more likely to have low downpayments and interest rates that are fixed for the life of the loan. These characteristics reflect the GSEs’ support of such mortgages through their underwriting guidelines and purchasing priorities. Together with lower interest rates, this support—and possibly other factors such as an ability to lock in a rate in advance of closing45—induces many borrowers to prefer conforming loans to jumbos. The data reflect this preference with a concentration of conforming loans at the upper limit.
These phenomena are observed in the Monthly Interest Rate Survey (MIRS) conducted by the Federal Housing Finance Board. Exhibit 1, based on this data source, shows the distribution of loans with loan-to-value (LTV) ratios above 80 percent.46 Loans below the limit are more likely to have an LTV above 90 percent than are jumbo loans. The jumbo-conforming difference is even more pronounced for LTVs above 95 percent.
This pattern reflects the GSEs’ willingness to accept the credit risk on loans with downpay- ments below five percent. As we discuss later in this study, the GSEs’ support for such loans enables many households to buy homes they would otherwise be unable to afford or to qualify for a conventional loan rather than a more costly or burdensome FHA loan.
Exhibit 1 Distribution of LTV for Fixed-Rate Conventional Loans with LTV>80% 1997-2005
The GSEs’ strong support of fixed-rate loans is illustrated in Exhibit 2. This chart, also derived from MIRS data, shows that home-purchase loans for amounts under the conforming limit are much more likely to carry a fixed rate than an adjustable rate. To some degree, this difference reflects the lower interest rates on conforming loans. As we pointed out in our 2001 study, however, the jumbo-conforming difference in the fixed-rate share is larger than can be explained by the difference in interest rates. Given the magnitude of most estimates of the jumbo-conforming differential, one would expect a difference in the fixed-rate share of about 10 percentage points. As Exhibit 2 shows, the difference in fact fluctuates around 40 percentage points.
The advantages of conforming loans lead prospective borrowers to prefer them to
Green and Wachter (2005) discuss Freddie Mac and Fannie Mae activities in the “To Be Announced” (TBA) market. Unlike private-label securitizers and due to their operations in the TBA market the GSEs are able to lock in rates with originators before the existence of the actual mortgage contract.
A loan with an 80-percent LTV is a loan that is equal to 80 percent of the value of the property.
The Freddie Mac and Fannie Mae Contributions to National Goals