How the Fannie and Freddie takeover affects you

The government takeover of Fannie Mae and Freddie Mac is designed to put downward pressure on mortgage rates and to ensure that home loans remain available.

Those goals are made crystal clear in the statements made by public officials.

"The primary mission of the two mortgage giants now will be to proactively work to increase the availability of mortgage finance," says James Lockhart, who will temporarily govern Fannie and Freddie.

Lockhart, head of the Federal Housing Finance Agency, adds that his agency will examine Fannie's and Freddie's fees "with an eye toward mortgage affordability."

Treasury Secretary Henry Paulson says the government has three objectives: "market stability, mortgage availability and taxpayer protection." That's another signal that the government wants mortgages to remain available, at good rates, to borrowers with a low risk of default.

The good news for the consumer is that money will still continue to flow, provided you have the ability to qualify."

"I think that the immediate impact will be somewhat positive. You'll see some drop in mortgage rates because it'll decrease the uncertainty that had pushed mortgage rates up this summer.

I can imagine a drop in mortgage rates of around a quarter of a percentage point, give or take about 5 basis points. A basis point is one-hundredth of a percentage point.

It's hard to guess the timing of such a rate decrease.  It might happen as soon as today, but possibly later, as people in the mortgage industry scratch their heads and assess the federal government's plan. Probably we're talking inside of two weeks.

Mortgage rates expected to fall soon

Mortgage rates are expected to fall because the Treasury Department will buy mortgage-backed securities. Here's why rates would fall as a result of the Treasury buying mortgage-backed securities:

When investors buy bonds, they have a wealth of choices. They can buy U.S. Treasury bills and notes, or corporate debt, or bonds from state and local governments. Or they can buy mortgage-backed securities, which behave much like bonds. Mortgage-backed securities are known as MBS in industry shorthand.

Fannie and Freddie guarantee the mortgage-backed securities that they issue, and those securities are deemed quite safe as investments. Not as safe as Treasury notes, but relatively safe. Fannie and Freddie are government-sponsored enterprises, or GSEs, and for decades they had implicit government backing. That backing is now explicit.

In the past few months, investors have rushed to the safety of Treasury notes and haven't been as eager to buy mortgage-backed securities. The lessened demand caused the prices of mortgage-backed securities to go down. When bond prices fall, bond yields rise, and that's what happened with mortgage-backed securities. As yields went up, so did mortgage rates. The difference, or spread, widened between Treasury yields and mortgage-backed securities.

Now that the Treasury will buy mortgage-backed securities, their prices should rise because of the greater demand. (The same thing would happen if the federal government bought, say, boxcar loads of sugar. You would expect sugar prices to go up.) When bond prices rise, yields drop -- so mortgage rates should follow.

Lockhart, whose department will run Fannie and Freddie, describes this succinctly when he says, "As the GSEs have grappled with their difficulties, we've seen mortgage rate spreads to Treasurys widen, making mortgages less affordable for homebuyers. While the GSEs are expected to moderately increase the size of their portfolios over the next 15 months through prudent mortgage purchases, complementary government efforts can aid mortgage affordability. (The) Treasury will begin this new program later this month, investing in new GSE MBS."

No change for jumbo loans

Because they are perceived as riskier, rates on jumbo mortgages have been unusually high for the last year. Historically, jumbo rates had hovered about a quarter of a percentage point above the rates for mortgages backed by Fannie and Freddie. Now they're about a full percentage point higher, and that gap is unlikely to fall soon.

The government's bailout of Fannie and Freddie won't affect rates on home equity loans or home equity lines of credit, either.