Understanding Mortgage Lending: The Role of Fannie Mae and Freddie Mac

If you’ve followed anything dealing with mortgages, you may have heard the terms Freddie Mac and Fannie Mae get thrown around. But, what the heck do they really mean? And you may ask yourself “Fannie Mae and Freddie Mac, what is the difference?”

Let’s first try to explain in it in Layman’s Terms.

One could say that McDonald’s and Burger King are probably the tops of burger joints. However, they don’t really differ from each other. They both make burgers and fries, but McDonald’s pricing is a little cheaper.

Well, Fannie Mae and Freddie Mac are like McDonald’s and Burger King.

They each do the same thing, buying and selling loans from banks. Fannie and Freddie buy loans from banks and package them into securities that are bought by investors. Banks use the money from the loans they sell to make new loans to home buyers. If they didn’t sell their loans they would have all their money tied up and less cash to lend so they want to be sure the loans they make will be bought.

To ensure their loans are sellable, they each use their own automated underwriting systems or software program that determines whether or not a loan is approvable for sale to each entity. So, they are really one and the same.

Let’s take a look at each entity.

Getting Started with Fannie Mae and Freddie Mac

Fannie Mae

Fannie, for short, is the larger of the two entities. It is larger than Freddie because Fannie buys loans from larger commercial banks. A few of the banks they buy loans from you may be familiar with. Banks like Chase and Wells Fargo, just to give you an idea.

Obviously, dealing with bigger banks means there are more guidelines to follow. This means that the borrowers have given a set of guidelines they must meet to qualify for a loan that Fannie will find acceptable.

This is where Fannie’s automated underwriting system comes in. Fannie’s automated underwriting system known as Desktop Originator (DU) determines whether or not a loan can be sold to Fannie. 

DU is a tricky system, but again, it is most commonly used.

Fannie buys Conventional, FHA, and VA loans. When it comes to qualifying, here is what Fannie looks for when approving each loan program.

 Conventional

  • Total debt-to-income ratio no more than 41%
    •  Can go as high as 50% with exceptional credit score, not always guaranteed though
  • Credit score as low as 620
    • Some lenders will allow a lower credit score with even stricter guidelines to follow
  • Down payment as low as 3%, known as a HomeReady loan

 FHA

  • Total debt-to-income ratio no more than 43%
    •  Can go as high as 56.99% with exceptional credit score
  • Credit score as low as 500
    • Most lenders will only allow a score as low as 580 because of risk involved
  • Down payment as low as 3.5% as long as credit score is 580-plus
    • Minimum down payment of 10% for credit score 579 and below

 VA

  • There is no true limit for the debt-to-income ratio
    • It comes down to residual income
  • No minimum credit score
    • Most lenders will only allow a score as low as 580 because of risk involved
  • No down payment necessary
    • The exception to this, if the borrower is a veteran and wants someone else on the loan that is not spouse, need a minimum 12.5% down

Freddie Mac

Freddie, for short, buys loans from smaller banks, so think of local banks, such as Northwest and First Commonwealth, just to name a few.

Since Freddie deals with much smaller banks, that means there are fewer guidelines to follow.

Freddie’s automated underwriting system is called Loan Product Advisor (LP) and like DU, it determines whether or not a loan could be sold to Freddie.

LP as mentioned doesn’t have as strict guidelines to follow, so sometimes if a loan can’t get accepted by Fannie, a lender will run the file through LP and get it approvable.

Freddie buys only Conventional and VA loans. When it comes to qualifying, here is what Freddie looks for each loan program.

 Conventional

  • Total debt-to-income ratio no more than 45%
    • Can go as high as 50.49% with exceptional credit score, not always guaranteed though
  • Credit score as low as 620
    • Some lenders will allow a lower credit score with even stricter guidelines to follow
  • Down payment as low as 3%, known as a Home Possible

 VA

  • There is no true limit for the debt-to-income ratio
    • It comes down to residual income
  • No minimum credit score
    • Most lenders will only allow a score as low as 580 because of risk involved
  • No down payment necessary
    • Exception to this, if borrower is a veteran and wants someone else on loan that is not spouse, need a minimum 12.5% down

If you are buying a home and your loan officer tells you your file isn’t approvable, ask them if they tried with Fannie first. If they say yes, then, kindly ask them to try running your file with Freddie. You may end up blowing your loan officer’s mind.

You may end up blowing your loan officer’s mind.

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