Takeaways
- Fannie Mae and Freddie Mac are government-sponsored entities and shareholder-owned.
- Fannie Mae and Freddie Mac enhance credit flow to the American housing market.
- Fannie Mae and Freddie Mac set loan limits and underwriting decisions for banks and lenders.
- Borrowers need a high credit score, income verification, and a low DTI ratio.
- Fannie Mae and Freddie Mac purchase mortgages and sell them to investors as mortgage-backed securities.
The homebuying process can be exciting and a little nerve-wracking. Whether you are a first-time homeowner or buying your second home, it is important to know what Fannie Mae and Freddie Mac do to power the mortgage loan industry. These sort of pseudo-shadow organizations help grease the whole mortgage ecosystem.
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Fannie Mae and Freddie Mac have a major influence on the mortgages Americans qualify for because they set the standard on conforming loan limits (more on this below) and power many of the underwriting decisions for banks and mortgage lenders. They are both government-sponsored enterprises and owned by shareholders.
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What are Government Sponsored Entities?
Government-sponsored entities, or GSEs, are financial services corporations created by the United States Congress to enhance the flow of credit to specific sectors of the American economy. These entities, primarily focused on the housing market, are pivotal in making home ownership accessible and affordable for millions of Americans. Fannie Mae (the Federal National Mortgage Association) and Freddie Mac (the Federal Home Loan Mortgage Corporation) are the two most prominent GSEs in the housing sector.
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GSEs hold a unique position in the American financial landscape. While they are privately owned, their government charter and the perception of implicit government backing allow them to borrow at lower interest rates than other financial institutions. This setup has been crucial in their mission to keep mortgage rates low and ensure a stable supply of mortgage funding. However, this perceived government guarantee also brings complexities, especially regarding taxpayer exposure to potential GSE losses, as witnessed during the 2008 financial crisis.
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What Do Fannie Mae and Freddie Mac Do?
Fannie Mae and Freddie Mac are the backbone of the United States housing finance system. Their operations are often behind the scenes and not typically visible to the average homebuyer. Fannie Mae and Freddie Mac's primary function is to provide stability, affordability, and liquidity to the mortgage market. They do this by purchasing mortgages from lenders such as banks and credit unions, which enables these financial institutions to free up capital to lend to more homeowners.
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After purchasing these mortgages, Fannie Mae and Freddie Mac package them into mortgage-backed securities, which are then sold to investors worldwide. This process injects significant liquidity into the U.S. mortgage market, ensuring a steady flow of funding for new home loans. The sale of mortgage-backed securities also helps to spread the risk of loan defaults.
Advantages of a Fannie Mae Loan?
Opting for a loan that conforms to Fannie Mae's guidelines can offer several benefits to borrowers. One of the primary advantages is the potential for competitive interest rates. Fannie Mae also offers a wide array of mortgage products to cater to different borrower needs. This diversity ensures that a broad range of borrowers can find a mortgage product that suits their financial situation.
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Accessibility is another key advantage, especially for first-time homebuyers or those with modest incomes. Fannie Mae sets guidelines that allow for lower down payments compared to some conventional loans, and they are generally more flexible regarding credit scores. Finally, Fannie Mae's HomeReady program is specifically designed to help low- to moderate-income borrowers with lower down payments and more flexible sources of funds, including gifts and grants.
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How to Qualify for Loan Approval by Fannie Mae or Freddie Mac
To qualify for a loan backed by Fannie Mae or Freddie Mac, you must have a strong credit history and a credit score that meets or exceeds the minimum requirement. While the exact score can vary depending on the lender and loan product, a credit score of 620 or higher is a common benchmark for what you need for these loans [1].
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Income and employment history play critical roles in the qualification process. Lenders will verify your income to ensure you have the financial stability to make monthly mortgage payments. This typically involves providing pay stubs, W-2 forms, and tax returns for at least the last two years. Planning to boost your income before purchasing your home may help you qualify for a higher mortgage.
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Your debt-to-income ratio (DTI) is another crucial factor. This ratio measures your total monthly debt payments against your gross monthly income. To qualify for a Fannie Mae or Freddie Mac loan, your DTI should not exceed 36%, although there may be some flexibility depending on the overall strength of your financial profile [2].
Do You Get Loans Directly from Fannie Mae or Freddie Mac?
It is important to understand that you do not obtain loans directly from Fannie Mae or Freddie Mac. Instead, these entities operate in the secondary mortgage market, which means they primarily deal with lenders instead of borrowers.
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Here’s how it works. When you apply for a conventional loan, you do so through a mortgage lender, such as a bank or a mortgage company. After you have applied and your mortgage is approved and funded, Fannie Mae or Freddie Mac might purchase your mortgage from the lender if it conforms to their guidelines. In 2024, the conforming loan limit for mortgages acquired by Fannie Mae and Freddie Mac increased to $766,550 for one-unit properties in most parts of the United States, which is an increase of 40,350 from 2023 [3]. This purchase is part of their role in providing liquidity to the mortgage market, enabling lenders to offer more loans to borrowers.
Smart Summary
Buying a home can be a fun and rewarding process. Being financially prepared and having your finances in order will help you get the house you want. Before applying for a mortgage, understanding how the mortgage industry works will give you a keen understanding to help negotiate the price of your home, down payment, the interest rate of your mortgage, application fees, and more. Fannie Mae and Freddie Mac change their conforming loan limits annually, so keeping pace with these limits will help you as you hunt for the perfect home.
(1) Fannie Mae. What is the minimum credit score requirement? Last Accessed February 1, 2024
(2) Fannie Mae. What is the maximum DTI allowed? Last Accessed February 1, 2024
(3) Federal Housing Finance Agency. FHFA Announced Conforming Loan Limit Values for 2024. Last Accessed February 1, 2024
