What is a government-sponsored enterprise (GSE)?

No matter what type of mortgage you use to buy a home in the U.S., you probably already have a relationship with a government-sponsored enterprise (GSE). From increasing liquidity in the mortgage market to providing affordable housing solutions, GSEs play a crucial role in shaping the homeownership landscape across the country.

Government-Sponsored Enterprise (GSE): Meaning and purpose

Government-sponsored enterprise (GSE) describes a quasi-governmental, privately held agency established by Congress to improve credit flow in parts of the U.S. economy.

In other words, while a GSE is supported and regulated by the government to help improve specific sectors of the U.S. economy, the company is privately run.

In the mortgage market, GSEs contribute to capital market liquidity, which is the market’s cash flow, by purchasing mortgages from banks.

How do GSE mortgages work?

Fannie Mae and Freddie Mac are well-known GSEs in the mortgage market. The companies don’t directly issue mortgage loans to home buyers. Instead, they are major buyers of consumer mortgages.

Suppose a lender has $300 million to lend to home buyers. If 1,000 borrowers take out a $300,000 mortgage with a 30-year term each, the lender will have to wait until the borrowers pay back their mortgages before they would have enough money to offer more loans.

When a GSE buys the lender’s mortgages, it puts money back into the lender’s hands to offer more mortgages to potential home buyers. The lender doesn’t have to wait for borrowers to repay their existing mortgages to originate new ones.

How do GSEs regulate the mortgage market?

GSEs help boost capital flow in the real estate market by purchasing a specific type and number of loans. Because they’re major buyers, GSEs can set the standards (or conforming guidelines) mortgages must meet to sell on the market.

The conforming guidelines set by GSEs help dictate the down payment, credit score and debt-to-income ratio (DTI) lenders use to qualify borrowers for conforming loans. GSEs also set maximum loan lending limits based on geographical location and property type.

Do all mortgages have to follow GSE criteria?

While lenders can offer home loans that don’t follow conforming guidelines, they typically issue conforming loans since they can quickly sell them to GSEs and free up capital to originate more loans.

Loans that don’t meet GSE criteria are called nonconforming or jumbo loans. Because nonconforming loans pose a higher risk to lenders, they usually have higher down payment and credit requirements.

GSE bonds vs. treasury bonds

The U.S. Treasury and private companies can issue bonds on the mortgage bond market, but there are some differences.

One of the significant differences between a GSE bond and a Treasury bond is that GSE bonds aren’t backed by “the full faith and credit” of the U.S. government, while U.S. Treasury bonds are.

In this context, “full faith and credit” is the U.S. government’s guarantee to repay investors their accrued interest and principal when the bond matures.

While GSE bonds carry both credit risk and default risk, the bonds usually offer a slightly higher yield than Treasury bonds.

Which are the most common mortgage GSEs?

While many homeowners may not know their names, it’s likely their mortgages have been sold to a GSE or are backed by one. To better acquaint yourself with these key players in the mortgage market, here are some GSEs to know:

Federal National Mortgage Association (FNMA Or Fannie Mae)

Founded in 1938, Fannie Mae purchases mortgages from mortgage lenders, such as large commercial banks, that they bundle and sell to investors as mortgage-backed securities. Fannie Mae went private in 1968 and was funded through the stock and bond markets for 50 years. However, after the Great Recession of 2008, Fannie Mae became a GSE again and is currently under the conservatorship of the Federal Housing Finance Agency (FHFA).

Federal Home Loan Mortgage Corporation (FHLMC Or Freddie Mac)

Freddie Mac was founded in 1970 to offer smaller lenders access to a reliable and affordable supply of mortgage funding. The significant difference between Fannie Mae and Freddie Mac is that Freddie Mac funds credit unions, community banks and other smaller lenders that support communities with less access to banking resources.

Government National Mortgage Association (GNMA Or Ginnie Mae)

Another key GSE in the mortgage market is Ginnie Mae. It was founded in 1968 to guarantee government-backed loans. The two most common government-backed mortgages are:

• Federal Housing Administration (FHA) loans: Allow home buyers with lower credit scores or past credit issues to buy homes for 3.5% down.
• Department of Veterans Affairs (VA) loans: Allow qualifying veterans, active duty service members and qualifying surviving spouses to buy homes for 0% down.

Unlike Fannie Mae and Freddie Mac, Ginnie Mae doesn’t buy or sell mortgages on the secondary mortgage market. Ginnie Mae guarantees these mortgages and backs them with “the full faith and credit” of the U.S. government.

Federal Agricultural Mortgage Corporation (FAMC Or Farmer Mac)

Congress established Farmer Mac in 1988. The GSE guarantees agricultural mortgage-backed securities purchased by investors. By purchasing loans from rural lenders and packaging them for sale to investors, Farmer Mac helps free up cash and available loans for agricultural projects. They achieve this by supporting the institutions that serve America's farming and rural communities, such as agricultural lenders and agribusinesses.

Former GSEs

Some organizations that used to be GSEs are no longer funded or managed by the federal government. However, their core function – to help consumers access the capital they need – has stayed the same.

• Federal Home Loan Banks (FHLB): FHLB was founded in 1932 to provide home loans during the Great Depression. Today, the U.S. federal government no longer manages it. The organization comprises 11 regional banking cooperatives that fund roughly 6,500 banks, credit unions, insurance companies and community development financial institutions.
• Sallie Mae: Sallie Mae, or the Student Loan Marketing Association, previously serviced student loans on behalf of the Department of Education. Since 2004, Sallie Mae has focused on servicing private student loans as a private company.
• Farm Credit System: The Farm Credit System, created in 1916, is a network of cooperating lenders and associations that provides capital to farmers, ranchers, agricultural producers, rural infrastructure providers and rural home buyers across the nation.

The bottom line

Without government-sponsored enterprises in the mortgage industry, it would be really hard to find available and affordable mortgages to buy a home, especially for low-income buyers or buyers with low credit scores.

The U.S. economy’s mortgage market enjoys liquidity and stability due to the behind-the-scenes work of GSEs and mortgage investors.

If you’re looking for a mortgage and want to see your options, you can start the application process today.