If you have a mortgage or are going through the homebuying process, you’ve probably heard of Fannie Mae and Freddie Mac. While the names might be familiar, there’s much to learn about the two biggest players in the housing market. We believe it is important for you to understand their roles in the industry and how they function. Here’s a quick rundown of what they are and what they do.
Who They Are: The names Fannie Mae and Freddie Mac are actually creative acronyms for their respective organizations. Fannie Mae represents the Federal National Mortgage Association (FNMA), and Freddie Mac the Federal Home Loan Mortgage Corporation (FHLMC).
What They Do: Fannie Mae and Freddie Mac are government-sponsored enterprises, more commonly known as GSEs. Their main function is to assist lenders by providing liquidity, or access to funds. This is done primarily through the purchase of loans from lenders. Lenders provide borrowers with loans for a home purchase or refinance, but they want to be able to do so for as many borrowers as possible. Most loans have a lifespan of around 30 years, but lenders are unable to wait out the lifespan before getting their money back. If they did, they could only help a few borrowers before running out of money. However, GSEs like Fannie Mae and Freddie Mac can make the 30-year commitment. Buying the loans allows lenders to have their money returned right away and lets them engage in further lending to more borrowers.
Here is an example of how this process works: A lender has provided a borrower with a 30-year, $100,000 loan to purchase a home. The lender is now out $100,000 and will have to wait 30 years before being fully paid back. They only had $100,000 to give, so now they don’t have any money to help other borrowers. Instead of taking on the loan, the lender sells it to Fannie Mae or Freddie Mac. Now they can use that money to help another borrower.
Quick Note: You might be wondering what Fannie Mae and Freddie Mac do with the loans they purchase. The two GSEs buy thousands of loans every day, but they don’t need to keep them all. Rather than holding onto all the loans, Fannie Mae and Freddie Mac can sell them to different institutions, such as City Bank or Wells Fargo. Because there are so many loans, the institutions like to buy pools, or collections of loans that have all the same parameters.
How They Compare: While very similar in function, there are some differences between Fannie Mae and Freddie Mac. Fannie Mae was established first in 1938, followed by Freddie Mac later in 1970. They use different Automated Underwriting Systems (AUS): Fannie uses Desktop Underwriter (DU) and Freddie uses Loan Prospector (LP). The two also differ in how they handle student loans, condominium reviews, and self-employed borrowers. However, the two are more similar than different. Both GSEs have set guidelines that every loan must meet before they purchase it, involving aspects such as income, asset, down payment, and credit requirements. They both provide conventional lending, rather than government lending like their competitor, Ginnie Mae. While Fannie Mae used to only offer a Debt-to-Income (DTI) Ratio of 45%, they recently matched Freddie Mac at 50%. Both also have a maximum Loan-to-Value (LTV) Ratio of 97%.
Without Fannie Mae and Freddie Mac, many Americans would be unable to purchase a home. Both are vital to the housing market, making it important that you have a general idea of who they are and their function, especially if you are beginning the homebuying process.
If you are interested in learning more about Fannie Mae or Freddie Mac or have any questions regarding the home buying process, contact one of our licensed Mortgage Loan Originators.
Recently, we answered the Top 5 Questions about FHA Loans. This week, we will discuss Conventional loans. If you are planning to purchase a home soon, read on to learn more about whether a Conventional loan might be the right financing option for you.
A Conventional or conforming loan is one which adheres to the guidelines set by Fannie Mae and Freddie Mac, and is not insured or guaranteed by the federal government. These loans can be fixed-rate or adjustable-rate. At any given time, approximately 35-50% of mortgages are conventional mortgages.
1) What kind of credit score do I need to qualify for a Conventional loan?
As with other loan types, credit score requirements for Conventional loans will depend on your lender. Conventional loans are designed for borrowers with good-to-great credit, and typically require a higher income and credit score than FHA loans.
2) What is the down payment amount for a Conventional Loan?
The minimum down payment for a Conventional loan is 3% for fixed-rate mortgages, and 10% for adjustable-rate mortgages. It is usually a good idea to have a larger down payment saved up, as a down payment of 20% or more on a Conventional loan means that you will not have to pay a monthly mortgage insurance premium in addition to your monthly mortgage payment.
3) How much can I borrow with a Conventional Loan?
Fannie Mae loan limits for Conventional loans vary by state and county. The current loan limit for a 1-unit property in the continental United States is $417,000. For counties in the U.S. that have been designated as high-cost areas, the loan limit is $625,500. To see what the loan limit is in your area, click here.
4) Should I get a fixed or adjustable-rate mortgage?
Conventional loans allow you to choose between a 15- or 30-year term, with a fixed or adjustable interest rate. A fixed rate mortgage means that your interest rate remains the same throughout the life of the loan. An adjustable rate mortgage means that your interest rate will fluctuate throughout the loan term, based on market conditions and other factors. An adjustable rate mortgage allows you to take advantage of falling rates without having to refinance; however, your monthly payments will change periodically. A fixed rate mortgage means that your monthly payments will not change, and that you will not be affected if interest rates go up. What type of loan you should choose depends on your financial situation and how long you plan to live in the house. Your Loan Originator can assist you in selecting the right loan type for your needs.
5) What are the benefits of a Conventional loan?
One of the main advantages of Conventional financing is that you will likely be eligible for lower interest rates than with an FHA Loan. Another advantage is that you do not have to purchase mortgage insurance with a down payment of 20%; and if you do opt for a lower down payment, your mortgage insurance premium may be cheaper than it would be with an FHA Loan. Additionally, should you need to take cash out for any reason during your mortgage term, you may be able to “cash out” up to 85% of your home’s value.
A Conventional loan can be an excellent choice for the right home buyer. If you have more questions about Conventional loans, contact one of our licensed Mortgage Loan Originators. If you are ready to begin the home buying process, click here to get started!