What Does the Term "Federally Backed Loan" Mean?

My name is Christine Springer. I'm a paralegal and the owner/founder of Desert Edge Legal. I am responsible for the content in this post. Please note that I am not an attorney and I cannot give you legal advice. Please consult with an attorney to discuss your individual situation.

I recently posted about how to find out whether your landlord's rental property is secured by a federally backed mortgage. It occurred to me today that there might be some people who don't have any idea what this means.

So, here's a little bit of education for you. Don't worry, it's not too difficult to understand.

Freddie and Fannie are both government sponsored entities, ("GSE's") which is an unusual entity type. I won't go into that here, but you can look it up and find out what the controversy is all about. These two entities invest in securities that contain loans. They invest in mortgage backed securities and commercial securities, and probably other types of securities as well.

If your landlord has a commercial loan or a home loan on the property where you live, there is a very good chance that the loan is securitized. That means that the loan was bundled together with other loans, packaged into a security or a pool of loans similar to it, and sold on Wall Street.

This is a type of debt (because there are loans against the assets in the pool) called an asset backed debt. It's attractive because people pay interest on the loans for the assets which generates a return on the investment for the investors. It's also attractive because if the property owner stops making the payment, the entity that owns the loan can take the property from the owner, which is called a foreclosure.

The government purchases shares in the loan pool through Freddie and Fannie as the investor in the loan pool (sometimes also called a trust). The loan pool is the owner. The investor does not own the loans directly. The investors have a say in how the loans are administered which is usually built into the terms of the security. The entity selling the mortgage pool wouldn't have many investors if they didn't like the terms of the mortgage pool.  

The GSE's probably have specific terms for the pools that they invest in. (I'm not an expert on GSEs, so please do your own research.) There are certain loan criteria that have to be met by the loans in the pool, such as borrower credit score and loan size, which is intended to reassure the investors that the loans in the pools were properly documented.

An important document called a Pooling and Servicing Agreement ("PSA") is one of many documents filed with the Securities and Exchange Commission ("SEC") as part of a securities offering. It's usually around 400 pages long and is full of information about the loans in the trust, interest rates and other stuff that investors consider important. There are many other documents that must be filed with the SEC, such as the Prospectus, periodic 10-Ks and 8-K's to name a few.

There may also be a Loan Schedule attached to the PSA that shows all the loans in the security. Loan schedules are rare these days. I located some home loans for homeowners on the loan schedules in the last foreclosure crisis but as time went on the schedules were not included with the PSA, making it more difficult to find whether a specific loan was actually in the pool.

The PSA is the document that governs the terms of the agreement between the trustee of the pool, the investors, the depositors and sets out the servicing requirements and administration of the pool, such servicing fees, loan maturity, and other information.

It's my understanding that the parties to the mortgage pools frequently work together to buy and sell the the securities, so they are usually in communication about the terms before these documents are filed with the SEC.

The SEC regulates securities. Securities laws are sometimes called "blue sky laws" because of the expectation of transparency. The idea is that investors must be thorough informed about the securities being offered before they purchase them.

This is what it means when the term "federally backed loan" is used. It means that Freddie and Fannie have invested in a loan pool that holds a loan.

Congratulations on completing Securitization 101! I hope this post was useful!