Fannie Mae vs. Freddie Mac
Fannie Mae and Freddie Mac, also known as the Federal National Mortgage Association (FNMA) and the Federal Home Mortgage Corporation (FHMC), are both the leading sources for finance in the housing market. They were created and continue to be supported by the federal government in order to promote a secondary market for residential loans. These government-sponsored enterprises (GSE) will purchase a mortgage loan from lending companies and package it with a collection of loans to sell to investors as mortgage-backed securities.
This system was designed to remove mortgages from the books of banks and credit unions so that they can restore their funds and continue issuing mortgages to qualifying homebuyers. While both enterprises use the same securitization method, they differ in their product and target market. For example, Fannie Mae loans are more common at large commercial banks. To learn more about Fannie Mae and Freddie Mac, read the following sections below.
How did Fannie Mae and Freddie Mac originate?
Fannie Mae was the first housing enterprise to be established by the federal government. It was created in 1938 following the collapse of banks and foreclosed homes during the Great Depression. Before the GSE, banks were issuing loans short-term loans with high-interest rates. Fannie Mae introduced the long-term, fixed-rate mortgage loan lasting up to 30 years.
This gave homebuyers the opportunity to refinance their mortgages whenever interest rates decreased. Soon after, Freddie Mac was created as competition to prevent the FNMA from becoming a monopoly. Before being taken into conservatorship in 2008, these GSEs relied heavily on the stock and bond markets to fund their operations. Due to the overwhelming issuance of subprime mortgage loans, these markets crashed placing both GSEs in trillion dollars’ worth of debt. Today, Freddie Mac remains directly backed by the U.S. Treasury while the government is morally obligated to Fannie Mae.
Learn more about the benefits of a Fannie Mae or a Freddie Mac home loan by downloading our in-depth guide.
Freddie Mac and Fannie Mae Loans
There is a common misconception that Fannie Mae and Freddie Mac originate and distribute loans directly to borrowers. However, this is not how Fannie Mae works. These entities purchase conforming loans from banks and credit unions and sell them as mortgage-backed securities on the secondary mortgage market. When selling MBSs, these GSEs guarantee that their investors will receive their principal and interest payments even if borrowers default on their mortgages.
This explains why both enterprises have strict underwriting guidelines that lending companies must adhere to when issuing mortgages. If Fannie Mae purchases subprime mortgage loans, there is a higher chance that the enterprise could plummet into major debt. To avoid this, both GSEs only accept conforming loans that meet their lending guidelines. This means that the loans must meet Fannie Mae loan limits set by the Federal Housing Administration (FHA). These limits vary by year and are determined based on the units and area of a home.
Unlike Fannie Mae, the FHMC purchases home loans from smaller financial institutions. This means that Fannie Mae loans are a lot more common for borrowers taking out loans from large commercial banks. These loans consist of both fixed-rate and adjustable-rate mortgages (ARM). Fixed-rate mortgages are home loans that contain fixed interest rates that do not change throughout the entire term length of a loan. This means if you obtain a fixed-rate mortgage loan for 30 years, your interest rate will remain the same unless you decide to go through the process to refinance your home. On the other hand, an adjustable-rate mortgage has an interest rate that fluctuates throughout the loan’s term. These variable interest rates are dependent on indexes and set margins. An ARM interest rate is typically offered at a lower rate.
This Freddie Mac loan option is best for homebuyers who only plan to own their home for a short period of time before interest rates increase on the housing market. If you are looking to finance a second home or investment property, then you may apply for a mortgage through both GSEs. Fannie Mae and Freddie Mac offer financing for both single-family homes and condominiums. If you are looking to refinance a home loan or renovate your home, then you may do so through both GSEs.
What are the eligibility requirements for a borrower?
Fannie Mae and Freddie Mac generally have the same underwriting guidelines when determining whether a homebuyer is eligible for a mortgage loan. For example, both GSEs will evaluate a homebuyer’s income, credit score and work history. These lenders will also consider the interest rate and mortgage down payment a borrower is capable of paying. These enterprises both limit an applicant’s debt-to-income ratio to a certain percent. Only applicants who are highly qualified in other aspects may receive a small percentage increase. Additionally, all applicants must meet the same minimum FICO credit score set by both enterprises.
While Fannie Mae and Freddie Mac share the same eligibility requirements, they vary greatly in the programs they use to assess a borrowers risk. If you are applying for a Freddie Mac loan, then you may find that it is easier to get approved than it is for a Fannie Mae loan. The Fannie Mae Desktop Underwriter is much more stringent when gathering information to make an informed decision on a homebuyer’s risk. On the other hand, the Freddie Mac Loan Product Advisor (LPR) system is much more lenient in efforts to give applicants a better chance at approval.
Fannie Mae Home Ready vs. Freddie Mac Home Possible
The Fannie Mae HomeReady and the Freddie Mac Home Possible programs both were created to make mortgages attainable for homebuyers with low down payments. While the HomeReady program only requires a low down payment at a decent credit score, the Home Possible program will disregard a homebuyer’s credit score if they agree to make a higher down payment.
When deciding which program is right for you, it is important to compare each programs’ guidelines. For example, the Fannie Mae program requires that a homebuyer obtain Fannie Mae HomeReady mortgage insurance to meet eligibility requirements. Furthermore, all applicants must meet their area’s median income unless they are applying for a mortgage in a low-income neighborhood.
To find out more about eligibility for Fannie Mae and specific details about minimum credit scores, download our comprehensive guide.