Mortgage Insights Blog

Without writing a dissertation on this subject I’ll try to provide a general understanding - first, the word “subprime” when referring to Fannie Mae and Freddie Mac is a misnomer— by definition, if Fannie and Freddie don’t purchase a loan it is considered to be a “non-conforming” loan. In the mortgage industry, true subprime loans refer to a certain category of non-conforming loans in which borrowers with really low credit scores were given loans with very aggressive terms (2 & 3 year fixed rates that flipped to very high adjustable rates).

So if Fannie and Freddie didn’t actually make any of these “subprime” loans, then how come they are in so much trouble? As the credit markets loosened, post September 11^th, there was both a lack of oversight and a political push for Fannie and Freddie to make more aggressive loans to low income and underserved neighborhoods. They also started allowing 100% financing to well qualified borrowers, loosened their stated income programs, and even instated “automatic underwriting systems” that offered borrowers the ability to waive their income documentation.

In addition, when the credit crisis first started—Fannie and Freddie tried to help the markets by purchasing, in the secondary markets, more of these “non-conforming” loans from financial institutions around the country in an attempt to stimulate more lending. They were not changing their guidelines by directly offering “subprime” loans but rather gambled in the secondary market by purchasing blocks of mortgages that were not selling on Wall Street.

Finally, come 2007 and 2008, as the Real Estate market dipped, the credit crisis spread to the conforming world where a lot of perfectly good loans became delinquent. Borrowers either found themselves upside-down in home equity or their short-term fixed rate mortgages had flipped to their adjustable rate periods at a time when the rates governing their payments were critically high. When home prices go down and it affects everyone, and with little to no equity in their homes and lack of financing available, borrowers turned to loan modifications, short sales or even foreclosure.

When you take all these factors into consideration, there was plenty of effect on Fannie and Freddie.