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Tuesday, March 19, 2013

An Overview of the Housing Finance System in the United States

Sean M. Hoskins
Analyst in Financial Economics

Katie Jones
Analyst in Housing Policy

N. Eric Weiss
Specialist in Financial Economics

When making a decision about housing, a household must choose between renting and owning. Multiple factors, such as a household’s financial status and expectations about the future, will influence the decision. Few that decide to purchase a home have the necessary savings or available financial resources to make the purchase on their own. Most need to take out a loan. A loan that uses real estate as collateral is typically referred to as a mortgage.

A potential borrower applies for a loan from a lender in what is called the primary market. The lender underwrites, or evaluates, the borrower and decides whether and under what terms to extend a loan. Many different types of lenders make home loans, including banks, credit unions, and finance companies (institutions that lend money but do not necessarily accept deposits). If a mortgage is made, the borrower sends the required scheduled payments to an entity known as a mortgage servicer, which then remits the payments to the mortgage holder. If the borrower does not repay the mortgage as promised, the lender can repossess the property through a process known as foreclosure. The lender requires some additional assurance that, in the event that the borrower does not repay the mortgage as promised, it will be able to sell the home for enough to recoup the amount it is owed. Typically, lenders receive such assurance through a down payment, mortgage insurance, or a combination of the two. Mortgage insurance can be provided privately or through a government guarantee.

The secondary market is the market for buying and selling mortgages. If a mortgage originator sells the mortgage in the secondary market, the purchaser of the mortgage could choose to hold the mortgage itself or to securitize it. When a mortgage is securitized, it is pooled into a security with other mortgages, and the payment streams associated with the mortgages are sold to investors. Fannie Mae and Freddie Mac securitize mortgages that conform to their standards, known as “conforming mortgages.” Mortgages that do not conform to all of Fannie Mae’s and Freddie Mac’s standards are referred to as “nonconforming mortgages.” Ginnie Mae guarantees mortgage-backed securities (MBS) made up exclusively of mortgages insured or guaranteed by the federal government. Other financial institutions also issue MBS, known as private-label securities (PLS).

The characteristics of the borrower and of the mortgage determine the classification of the loan. What happens to a mortgage in the secondary market is partially determined by whether the mortgage is government-insured, conforming, or nonconforming. Depending on the type of MBS or mortgage purchased, investors will face different types of risks.

Congress is interested in the condition of the housing finance system for multiple reasons. The mortgage market is very large and can impact the wider U.S. economy. The federal government supports homeownership both directly (through the Federal Housing Administration [FHA], Department of Veterans’ Affairs [VA], and U.S. Department of Agriculture [USDA]) and indirectly (through Fannie Mae and Freddie Mac). This support by the federal government means that the government is potentially liable for financial losses. Fannie Mae, Freddie Mac, and FHA currently are in financial difficulty, and Congress has shown an interest in exercising oversight and considering legislation to potentially address these difficulties.

This report provides an overview of how the housing finance system works and provides context for housing finance-related policy issues that Congress might choose to consider. A glossary of terms is provided in the Appendix.

Date of Report: March 13, 2013
Number of Pages: 21
Order Number: R42995
Price: $29.95

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