What’s up with the housing market in America? It was my opinion as a child that purchasing a home was a routine and boring procedure. A family would save up over a number of years to gather enough money to purchase a home. They would then use that home as a foundation for a family and work to improve and maintain that home. I suppose this belief was a reflection of my experience growing up in a suburban environment and meeting throngs of people who could relate to my experiences. Several years later, at age 23, I’ve developed some new feelings about housing, how it became a “market” and what the important risks and rewards are to participating in this market. My first eye-opening experience was discovering that taking out a mortgage means more than the bank handing you a pile of cash.
I had thought it a good idea to avoid renting in New York City by persuading my mother to lend me a down payment, securing a loan myself, and paying back the principal and interest of my mortgage though my ability to rent out space in the apartment to friends. This way I figured, I’ll actually own something rather than rent someone else’s space. My conceptual attitude of being a landlord was correct, but the realities of managing a property are far more exhilarating than sitting back and collecting rent checks.
I contacted a friend of the family who was a mortgage broker to learn how I could secure a loan. I learned that I’d need to prove my ability to repay several hundred thousand dollars to a bank through tax statements and other relevant financial documents, rather than talking up my popularity and ability to find a roommate. The bank didn’t even want to try to rationalize my landlord attitude and desire to stuff multiple tenants into buildings where subletting might be questionable to begin with.
When you take out a mortgage from a bank, the bank is thrilled because they are lending you out money at an interest rate higher than what they are borrowing the money for. For example, if you secure an 8% interest rate on a 30-year term mortgage, and the bank is obtaining those funds to lend you from a larger bank at a rate of 6%, that bank is making 2% profit on you- minus certain expenses. If you’re borrowing $500,000 the bank will earn $10,000 (2%) as a finder’s fee and for servicing that mortgage. Next, Fannie Mae comes along, a government agency which buys up large pools of mortgages in an effort go and create large-scale liquidity in the housing markets. They tell the smaller bank, where the mortgage originated, that for a small fee (say ¼% or so) they’ll buy up that mortgage from the bank, service it for them, and take care of all the administrative duties. Banks jump at this opportunity because they can then focus on obtaining more mortgages and outsourcing any real effort it might take to service the mortgage. Better still, Fannie Mae goes ahead and packages up the mortgages into little securities, called Collateralized Mortgage Obligations (CMO’s) and sells them to the investing public on an open market. This actually creates a full circle where the person owning the mortgage, could, ultimately be buying back a piece of their own mortgage and being paid to do so.
This delegation of responsibilities sounded dangerous to me upon learning about how many hundreds of people could be splitting up the financing of just 1 mortgage. What prevents Fannie Mae from defaulting a payment to a holder of a CMO and therefore defaulting on their obligation to a shareholder? Or, what would Fannie Mae do if the person who took out the mortgage was unable to make a few months payments. Would the bank that originated the loan have any further obligations, or is it all on the shoulders of Fannie Mae, since they bought up the loans. Perhaps the default risk is transferred to the holders of the CMO’s since they would otherwise benefit (risk free) from buying these securities.
I learned the answer lies somewhere in between all of these answers. The government actually backs Fannie Mae in situations where default may come about, and even pay to be involved in the day-to-day operations of the Fannie Mae (Federal National Mortgage Association’s) day-to-day activities. They do this because of the huge number of mortgages which Fannie Mae finances, and the extreme need for this sort of liquidity in the American housing market.
My understanding of the whole process actually made pursuing it less of a priority for me. I felt as though once I secured a mortgage and bought the property, I was entering a maze where everyone had a definite end but me. I would be a risk taker at many levels since the risk was new and my resources were questionable. Why not attack from a different angle I figure- somewhere in the production chain where I could squeeze right in.
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