FORTUNE – Efforts to wind down the government’s support of America’s biggest mortgage companies are gaining traction; the question now is how much more could it cost homebuyers if Congress scales down Freddie Mac and Fannie Mae, or ends the companies altogether.
Recall that Freddie and Fannie collapsed in 2008 after huge losses from far too many mortgages that went sour. The companies don’t actually make home loans — they buy mortgages from lenders, which are then packaged as bonds and sold to investors. For years, that helped banks reduce risks on their balance sheets. It also freed up more money for banks to lend and therefore helped hold down interest rates. If borrowers defaulted, the companies promised to repay investors thanks to an implicit guarantee they had from the U.S. government.
This system worked for many years until the housing market bubble burst; the government rescued Freddie and Fannie with a bailout of nearly $200 billion.
It’s clear now that nobody, especially taxpayers, wants to relive the crisis, or to pay for any more screw-ups. And on Tuesday, President Obama joined the mantra, calling for changes to Freddie and Fannie, similar to the Senate’s bipartisan plan, which would phase out the companies over five years and shrink the government’s role in guaranteeing mortgage securities. The idea of winding down Freddie and Fannie isn’t anything new. As early as 2010, if not earlier, Republicans, in particular, have been calling to downsize the mortgage giants. What makes the efforts different today is that the housing market has turned around and so have Freddie and Fannie, which guarantee 80% of all new U.S. home loans.
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In the latest proposals, taxpayers would receive more protection, but that will likely come at some costs to the average homebuyer in the way of having to pay higher interest rates.
Mark Zandi, chief economist at Moody’s Analytics, has come up with a few estimates. If he’s right, under the Senate’s plan, the typical borrower with a $200,000 mortgage and a 20% down payment could pay about $75 per month more in interest on a 30-year mortgage, or about half a percentage point more. Under the House plan, which would virtually privatize the mortgage market, borrowers on average would pay about $135 more a month.
Nobody is saying yet that scaling down Freddie and Fannie will destroy the housing market. To be sure, many other important details are unclear.
Besides paying more in interest, borrowers may also pay more, if only indirectly, into a government-run insurance fund. Under the Senate’s plan, the government would continue playing a role in the mortgage market, albeit a limited one that would create a new Federal Mortgage Insurance Corp. This is similar to the way the Federal Deposit Insurance Corp insures bank deposits. The FMIC would collect insurance premiums from the industry and keep an insurance fund, which would kick in if a “substantial amount” of private capital is used up, according to the Senate’s bill sponsored by Sens. Bob Corker (R-Tenn.) and Mark Warner (D-Va.).
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The question is what would be considered a “substantial amount.” Also uncertain is how much the premiums could cost lenders, as well as how much gets passed onto borrowers.
The biggest question of all, perhaps, is if the mortgage market is left entirely up to the private sector, could the popular 30-year-fixed rate mortgage cease to exist? This will largely depend on the creation of an FMIC, which would absorb many of the risks that come with such long-term loans, Zandi says. If the mortgage industry is left entirely up to the free market, it becomes less likely that lenders would offer such loans that have made buying more affordable for many borrowers.
