Are Mortgage-Backed Securities Guaranteed?

Investing News
admin
February 12, 2025
0
8
12 minutes read

Reviewed by Doretha Clemon

What Is a Mortgage-Backed Security Guarantee?

A mortgage-backed security guarantee assures the timely payment to an investor of their portion of the payments of principal and interest received on the pool of mortgage loans that underlies a mortgage-backed security.

Should borrowers default on their mortgage loans and fail to make principal and interest payments, investors holding guaranteed mortgage-backed securities will receive the appropriate cash flow amounts to which they’re entitled.

Whether a mortgage-backed security (MBS) is guaranteed depends on the entity that issues the security. The government agency and government-sponsored enterprises Ginnie Mae, Fannie Mae, and Freddie Mac guarantee MBS.

Ginnie Mae does not issue mortgage-backed securities. But Fannie Mae and Freddie Mac do.

By creating and/or guaranteeing MBS payments, Ginnie Mae, Fannie Mae and Freddie Mac serve a vital role. They attract investors who might not choose to invest in mortgages and increase the pool of funds available for housing.

Key Takeaways

An MBS is a security created by pooling mortgage loans and represents the cash flow associated with those loans.
An MBS guarantee means investors who hold the securities are guaranteed the timely pass through of that cash flow.
The MBS guarantors are Fannie Mae, Freddie Mac, and Ginnie Mae.
Ginnie Mae, a government agency, does not issue mortgage-backed securities but guarantees those issued through certain government programs and by qualified private issuers.
Fannie Mae and Freddie Mac, though not government agencies, provide guarantees of timely payment for securities that they issue.

How a Mortgage-Backed Security Guarantee Works

If mortgagors begin to default on their mortgages, a lender may have a difficult time passing through mortgage payments to MBS investors.

Depending on how diversified the underlying pool of mortgages is across demographic and geographic regions, default risks may be mitigated.

However, if a significant number of borrowers begin to default on their loans, the lender may default on their cash flow payments for an MBS.

This level of default could cause investors a great deal of financial distress. Thus, there’s a need for some form of MBS guarantee to maintain investor confidence and loan liquidity.

Such guarantees are provided by Fannie Mae, Freddie Mac, and Ginnie Mae. Fannie Mae and Freddie Mac guarantees are not backed by the U.S. government. Ginnie Mae guarantees are.

What Is a Mortgage-Backed Security?

A mortgage-backed security is a financial security backed by mortgage loans. It’s created by securitizing those loans. That is, loans made to individuals and companies to purchase buildings and homes are pooled by the lenders (banks and other mortgage loan originators). Then they’re sold to other financial entities, such as investment banks and other banks, which issue securities that represent those pooled loans. Investors who buy the securities receive a share of the principal and interest cash flow paid on the mortgages by the original borrowers.

Guarantors of Mortgage-Backed Securities

Fannie Mae

Fannie Mae (the Federal National Mortgage Association) is a publicly-traded government sponsored enterprise that was created by Congress in 1938.

It buys mortgage loans from lenders and, as a result, provides the funding that these lenders need to make additional loans to people seeking to buy homes.

In fact, Fannie Mae was established to maintain capital liquidity and to ensure that low- to middle-income individuals can purchase homes with affordable mortgage loans.

Fannie Mae can securitize the loans it buys and issue MBS. It also provides a guarantee for those securities. This guarantee is backed by its own financial health, not by government money.

Fannie Mae’s MBS Guarantee

Fannie Mae guarantees the pass through to MBS investors of the full and timely payment of the principal and interest paid on loans.

This guarantee reduces investor risk and increases an MBS’ marketability.

Fannie Mae is ultimately responsible for the MBS certificates and payments of principal and interest. The organization follows strict underwriting guidelines to assess the credit quality of the loans that it guarantees.

Freddie Mac

Freddie Mac (the Federal Home Loan Mortgage Corporation) is similar to Fannie Mae in that it is also a GSE and is shareholder-owned. Also like Fannie Mae, it does make loans to borrowers, it buys them from lenders.

It was created by Congress in 1970 to provide competition in the secondary mortgage market, which Fannie Mae originally monopolized.

Freddie Mac’s Guarantee

Freddie Mac uses the loans it buys to issue MBS that it guarantees for investors. Its guarantee is not backed by the government.

The organization can stand behind its guarantees and fund its loan loss reserves due in part to the guarantee fees it charges banks.

Ginnie Mae

Ginnie Mae (the Government National Mortgage Association) differs from Fannie Mae and Freddie Mac in that it operates as a government agency. Its guarantees are backed by the full faith and credit of the U.S. government.

It does not issue MBS but it guarantees those MBS backed by loans insured by these programs:

The Federal Housing Administration (FHA) single- and multi-family mortgage insurance program
The Department of Veterans Affairs (VA) guarantee program
The Office of Public and Indian Housing within the Department of Housing and Urban Development (HUD)
The U.S. Department of Agriculture Rural Housing Service loan guarantee program

Furthermore, Ginnie Mae guarantees MBS issued by qualified private institutions.

The Guarantee Is Backup Coverage

Importantly, Ginnie Mae’s guarantee provides backup coverage in cases where MBS issuers cannot cover losses due to borrower defaults.

It has a stringent guarantee approval process for MBS issuers. Issuers must be able to prove that they can meet their obligations to service the underlying loans and to step in to handle losses that occur if borrowers fail to make payments on their loans.

Private Issuers

Private issuers also issue MBS. If a private issuer meets the agency’s qualification threshold, its issue is guaranteed by Ginnie Mae. If, on the other hand, it is not qualified by Ginnie Mae, then the MBS issue is not guaranteed.

Does Private Mortgage Insurance Protect Ginnie Mae Investors?

Mortgage loans are secured for a lender by the properties purchased by borrowers. In addition, mortgages often require that the borrower purchase mortgage insurance. However, this type of insurance protects only the lender. It has nothing to do with investors who buy MBS.

Can the U.S. Government Help Fannie Mae and Freddie Mac?

Although they are not government agencies, it’s assumed that Fannie Mae and Freddie Mac have access to some financial assistance from the U.S. government. In fact, during the 2007-2008 financial crisis, the government bailed them out when mortgage loan losses overwhelmed them.

Does Anyone Else Guarantee Mortgage-Backed Securities?

MBS that are issued by private financial entities aren’t necessarily guaranteed by their issuers and do not have a government agency or GSE guarantee. Ginnie Mae could provide a guarantee if the issuer meets its rigorous qualifications. Privately-issued MBS not guaranteed by Ginnie Mae, Fannie Mae, or Freddie Mac typically offer higher potential returns to compensate investors for their greater risk.