Government Sponsored Enterprise (GSE) Mortgages: What They Are And How They Work

If you’ve purchased a home – or even if you haven’t – you’ve probably heard of Fannie Mae and Freddie Mac. These entities are what are known as government-sponsored enterprises (GSEs) and have the goal of providing stability and liquidity to the mortgage market.

GSE mortgages have plenty of benefits for both lenders and investors. They also create an investment opportunity for individual and institutional investors who want to make money from the mortgage market.

What Are Government-Sponsored Enterprises (GSEs)?

Government-sponsored enterprises (GSEs) are government-supported, privately operated companies or agencies that Congress has created to improve a certain area of the United States economy. GSE mortgages are meant to raise credit in the real estate housing market by purchasing home loans and selling them as mortgage-backed securities.

GSEs – especially Fannie Mae and Freddie Mac – provide liquidity and stability to the mortgage industry. They also reduce borrowing costs and ensure that home loans are available to more people.

GSE Vs. Government Agency

As we mentioned, while GSEs are supported by the government and are often created by Congress, they are privately operated. They receive some financial benefits from the government but are also subject to certain regulations.

These GSEs are very different from government agencies. After all, government agencies aren’t just regulated by the government – they’re a part of it. Like GSEs, government agencies are usually established to carry out a specific purpose. They exist within a certain branch of government, and employees of the agency are government employees.

How Does A GSE Work With Mortgage Loans?

The term GSE mortgage can be a bit misleading because GSEs don’t actually write mortgages. Instead, a financial institution issues the mortgage to the home buyer. The GSE guarantees the loan, meaning they purchase the loans that banks and credit unions underwrite. The GSEs then securitize the loans, meaning they pool them together to create securities that investors can buy.

GSEs provide a few different benefits for the mortgage industry. First, they reduce borrowing risk for lenders. Because lenders know that GSEs will purchase their loans (as long as they meet the GSE’s borrowing requirements), lenders know they’ll be able to get the loan off their books. Additionally, lenders can worry less about default risk.

GSEs also have benefits for borrowers. First, because the GSEs provide liquidity to the mortgage market, lenders are able to write more mortgages. Not only that, but they can generally offer mortgages at a lower cost for borrowers.

Additionally, because GSEs reduce default risk for lenders, those lenders may be more willing to write mortgages for borrowers they otherwise wouldn’t.

Government-Sponsored Enterprise Bonds Vs. Treasury Bonds

As we’ve discussed, GSEs securitize the mortgages they purchase in the form of mortgage bonds. These bonds represent pools of mortgages and are secured by the underlying properties. Individual and institutional investors can make money by investing in these mortgage bonds and earning interest from the underlying mortgages.

An important difference between GSE bonds and Treasury bonds is their default risk. GSE bonds have credit and default risk. There’s a chance the borrowers of the underlying mortgages could stop making their mortgage payments, which could result in default of the bond.

Treasury bonds, on the other hand, are backed by the full faith and credit of the U.S. government. As a result, they’re about as safe an investment as you can find. The downside, of course, is Treasury bonds tend to have lower returns than GSE bonds.

Types Of Mortgage GSEs

There are several different GSEs in the mortgage industry, including Federal Home Loan Banks, Fannie Mae, Freddie Mac and Farmer Mac.

Federal Home Loan Banks

The Federal Home Loan Bank (FHLB) system is a GSE that was created by the Federal Home Loan Bank Act passed in 1932. It’s composed of 11 regional banks and 6,800 member financial institutions. Like other GSEs in the mortgage industry, this one helps support and provide liquidity to the housing market.

Fannie Mae

Fannie Mae – short for the Federal National Mortgage Association (FNMA) – was created by an act of Congress in 1938 to help make affordable housing accessible to homeowners, homebuyers and renters. Fannie Mae is one of the largest buyers of conventional loans.

Freddie Mac

Freddie Mac – short for the Federal Home Loan Mortgage Corporation (FHLMC) – is a GSE that was founded in 1970 as a part of the Emergency Home Finance Act. Freddie Mac was created to support the U.S. housing finance system and ensure reliable and affordable mortgages.

Federal Farm Credit System

The Federal Farm Credit System is a national network of lending institutions that are owned by borrowers. It was created in 1916, making it the oldest GSE in the mortgage industry. The Federal Farm Credit System plays a similar role in the industry as other GSEs, but specifically in the agriculture industry.

Farmer Mac

Farmer Mac – short for the Federal Agricultural Mortgage Corporation (FAMC) – is the nation’s largest secondary market for agricultural credit. It was founded by Congress in 1987 in response to the nationwide farm crisis. It was created to increase access to and reduce the cost of capital for the agriculture industry and rural communities.

Is Ginnie Mae A GSE?

The Government National Mortgage Association – known as Ginnie Mae – is frequently lumped in with Fannie Mae and Freddie Mac as a GSE. While it plays a similar role in the industry, it’s a government agency rather than a GSE.

Ginne Mae was originally a part of Fannie Mae. But in 1968, the Housing and Urban Development Act split the two, establishing Ginnie Mae as a government corporation within HUD.

Ginnie Mae guarantees the timely payment of principal and interest on securities for investors. It specifically guarantees securities backed by FHA loans, VA loans, RHS loans and PIH loans. Because Ginnie Mae is a government agency, these securities are backed by the full faith and credit of the federal government.

The Bottom Line

Government-sponsored enterprises play an important role in the mortgage industry. They create stability and liquidity, making it easy and more affordable for borrowers to get mortgages. While they aren’t technically government agencies, GSEs were created by acts of Congress to address problems in the mortgage industry.

Are you in the market for a mortgage? Start your mortgage application to see how much you’ll qualify for.