The Federal Reserve System (The Fed).

Maybe you remember Tom Hanks mentioning the FRS in the hit film “Catch Me If You Can.”  Hanks’ character explains to a room of FBI agents that there are 12 branches of the Federal Reserve identified by numbers 01-12. At the bottom of a check there is a marker starting with one of those numbers. That number dictates where the check must be routed.

The Fed was established in 1913 by Congress to be the central bank of the United States. The point was to provide American Citizens with a stable and safer monetary system (ironic that this establishment was before the Great Depression…but that’s neither here nor there).

The FRS has 3 specific duties and 3 specific methods to carry out those duties.

Primary duties include:

  1. Conducting the Nation’s Monetary Policy
  2. Supervising and regulating financial institutions, protecting the consumer
  3. Maintain the stability of the financial system

Monetary Policy -  Think Macroeconomics. This policy gives responsibility to the Federal Reserve System to take action by influencing the availability of funds and determine the value of money and credit, ultimately promoting national economic goals.

Now that we know the Noun (the policy) let's discuss the verbs (actions that affect you and me)? The FRS has 3 methods to carry out Monetary Policy. Some are used more than others…some are more effective than others. Let’s take a look:

OPEN-MARKET OPERATIONS

The FRS decides how much money they want available and circulating in the economy. They control it by buying and selling government securities.

When the FRS sells securities through open-market trading they hold onto the funds received from the sale, thereby reducing the amount of money available to the public.

Moreover, less money is available for loans, causing interest rates to rise. High interest rates typically deter individuals from taking out loans which slows down the economy and reduces inflation.

When the economy is perceived to need a boost, the FRS buys securities which increases money in circulation. This is typically accompanied with a reduction in interest rates.

DISCOUNT RATE

The Discount Rate is the rate at which member banks and financial institutions borrow money from the FRS. Think of it as an interest rate on a loan. If the FRS increases the discount rate, it trickles down to consumers in the form of being charged higher interest rates on loans by the financial institutions.

This method is not considered to have the greatest long-term effect and is therefore not used as often as open-market operations.

RESERVE REQUIREMENT

Financial Institutions have a certain reserve requirement placed on them in the form of a percentage. They must keep a certain minimum percentage on hand at all times. They can’t spend it or loan it out. The FRS sets this percentage and can increase or decrease it.

Increasing the requirement causes less money in circulation and higher interest rates whereas decreasing the requirement increases the money in circulation and typically decreases interest rates. Changing the Reserve Requirement is considered the most drastic of the 3 methods and is therefore not used very often.

PRIMARY MORTGAGE MARKET

Now that we understand the Federal Reserve System, let’s discuss the different types of financial institutions. Since this is an article pertaining to real estate and mortgage loans, we will refer to these financial institutions as the Primary Mortgage Market because they originate the mortgage loans. We will discuss Commercial Banks, Savings Associations, Credit Unions, and Mortgage Lenders.

COMMERCIAL BANKS

  • Make Conventional, FHA, and VA loans
  • Specialize in Construction Loans (residential and commercial)
  • Have a Concentration in Home Equity Loans
  • If chartered by the Federal Government, must display the word ‘National’ or ‘NA’ 
  • Insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 

SAVINGS ASSOCIATION

  • Invests in Residential Mortgages and Home Equity Loans
  • Specialize in Conventional loans with some experience with FHA and VA loans
  • Chartered by Federal or State Governments
  • If Chartered by Federal Government, must display ‘Federal’ or ‘FA’ 
  • Insured by the Federal Deposit Insurance Corporation (FDIC) up to $250,000 

CREDIT UNIONS

  • Nonprofit Cooperative Organizations
  • Maintain saving and checking accounts for their members
  • Make home mortgage loans and home improvement loans
  • Can make 30 year mortgage loans to finance principal residences
  • Federal and some State Credit Unions are insured by the National Credit Union Administration which backs deposits up to $250,000

MORTGAGE LENDERS

  • Full service mortgage companies from process to closing of the loan
  • Originate loans with their own funds or borrowed capital
  • They package and sell loans to the Secondary Mortgage Market
  • Mainly work with FHA and VA loans

SECONDARY MORTGAGE MARKET

I will close with a broad brush summary of the Secondary Mortgage Market. If you didn’t know this already, your mortgage, through XYZ Bank or ABC Mortgage Company, gets sold to the Secondary Market. Why? Mainly to free up their capital (remember the Reserve Requirement?) and to make more money (gasp!).

The Secondary Mortgage Market is the principal source of mortgage capital in the United States and accomplishes two very important goals. First, it circulates the money supply, and second, standardizes loan requirements.

You may have heard their names before…do Fannie Mae, Freddie Mac, or Ginnie Mae ring any bells?

FANNIE MAE

(Federal National Mortgage Association)

  • Established by Congress in 1938
  • Initial goal was to stimulate the housing market after the Great Depression
  • Largest participant in the Secondary Mortgage Market
  • Purchases Conventional, FHA, and VA loans originated by Commercial Banks
  • Issues mortgage-backed securities to investors

FREDDIE MAC

(Federal Home Loan Mortgage Corporation)

  • Established by Congress in 1970
  • Purchases Conventional Loans originated from Savings Associations

GINNIE MAE 

(Government National Mortgage Association)

  • Part of Housing and Urban Development (HUD)
  • Serves as a guarantor of mortgage-backed securities
  • Guarantor of FHA and VA loans

IN SUMMARY

There’s more that goes into your mortgage loan than meets the eye. Many entities are at play dictating your interest rate, subconsciously encouraging or discouraging the borrowing of money. My hope is that with this knowledge you gain confidence and understanding as you seek to enter the Real Estate Market! 

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