Fannie Mae vs. Freddie Mac: What You Need to Know
Fannie Mae and Freddie Mac are two names that are constantly thrown around in the world of home finance, but what are they, really? The answer is both somewhat simple and somewhat complex at the same time. Fannie Mae and Freddie Mac are both government-sponsored enterprises (GSEs), which means that they’re private companies sponsored by the U.S. government. Both Fannie Mae and Freddie Mac have basically the same goal: to make it easier for the average American to obtain a home, by making it easier for them to get a mortgage on good terms.
What are the Differences and Similarities Between Fannie Mae and Freddie Mac?
While Fannie Mae and Freddie Mac are entirely separate organizations, they operate in a somewhat similar fashion. They both buy loans from private lenders and pool them into mortgage-backed securities (MBS), which are sold on the open market. While Fannie Mae mainly buys mortgages from big commercial lenders and banks (think Wells-Fargo, QuickenLoans, JPMorganChase), Freddie Mac mainly focuses on purchasing home loans from smaller lenders, which are often, but not always, local in nature.
How Do Fannie Mae and Freddie Mac’s Purchasing Activities Make It Easier to Get a Mortgage?
While it might come as a surprise to some, anyone who has attempted to purchase a home in a foreign country will quickly realize that most countries do not offer 15, 25, and 30-year mortgages. For instance, the vast majority of mortgages in Canada aren’t longer than 5 years. After that, a borrower will have to refinance their home at the going market interest rate-- even if that means a big increase in their monthly mortgage payments. This is because lenders do not like locking up their funds for long periods of time-- as it increases their risk and lowers the potential returns they may get.
In the U.S., a lender can make a loan and sell it to Fannie Mae and Freddie Mac-- which generally means they get all their money back (plus a certain amount of interest and applicable fees). In short, they’ve made back their principal (and a little bit of profit) no longer have to worry about the loan, even if it has a 30-year term. In most cases, the lender will use those funds to make another mortgage loan to another person, which they can also sell to Fannie or Freddie-- and that’s exactly what Fannie Mae and Freddie Mac want them to do. More mortgages being offered means more homeowners, which leads to stronger families and a more stable economy.
Like we mentioned earlier, the loan that Fannie or Freddie will be packaged with thousands of others to become mortgage-backed securities, which are basically bonds that investors can purchase.
What Should Borrowers Know About Fannie Mae?
Fannie Mae, which is an acronym for the Federal National Mortgage Association, was founded by U.S. president Franklin Delano Roosevelt back in 1938 (during the Great Depression) in order to stimulate the US. by increasing the availability of mortgages for average Americans. In 2017, Fannie Mae pulled in an incredible $109.9 billion in revenue. Like Freddie Mac, Fannie Mae is a publicly traded corporation, which means that everyday Joes can buy shares in it. While it used to be listed on the New York Stock Exchange, like other big corporations (think Apple, Google, Ford, Coca-Cola), it’s now traded over-the-counter only. This is because it lost a ton of money during the 2008 housing crisis and got pulled off the exchange.
What Should Borrowers Know About Freddie Mac?
Freddie Mac, which is an acronym for the Federal Home Loan Mortgage Corporation, is a lot younger than Fannie Mae, having been founded in 1970. As mentioned previously, Freddie Mac has the same basic goals as Fannie Mae-- but instead of purchasing home loans from large lenders, it focuses on buying mortgages from smaller lenders, like credit unions and local savings and loan organizations. In 2017, Freddie Mac pulled in $16.24 billion in revenue, which, while substantial, is only a small fraction of Fannie Mae’s revenue for that year.
Fannie Mae, Freddie Mac, and the 2008 Housing Crisis
During the 2008 housing crisis, Fannie Mae and Freddie Mac both nearly failed, as they had overextended themselves in an attempt to make loans available. They had even gone as far as to purchase thousands of subprime mortgage loans in a failed attempt to calm the market. As a result, Fannie and Freddie needed to get bailed out by the U.S. government to avoid going bankrupt. After this occurred, the two organizations were put under government conservatorship-- which simply means that the government decided that it needed to manage their day-to-day affairs in order to make sure they got back on track.
Today, both Fannie Mae and Freddie Mac are under the conservatorship of the Federal Housing Finance Agency (FHFA), an independent U.S. government agency which is not related to the FHA. The U.S. Treasury actually owns all the preferred stock of both companies, which means that they have full control over the direction of each organization. Members of the public, however, can still buy non-preferred shares.
Fannie Mae and Freddie Mac vs. The FHA
Fannie Mae and Freddie Mac are often compared with the FHA or Federal Housing Administration-- but in reality, the function of these organizations are wildly different. Unlike Freddie Mac and Fannie, the FHA actually provides insurance for loans, meaning that if a borrower defaults on an FHA-insured loan, the government will reimburse them for part or all of their loss. In contrast, Fannie and Freddie actually buy loans from lenders, taking them off their books-- and absolving lenders of all risk after a borrower’s loan has been purchased. Despite their differences, it’s true that all three organizations are intended to have a similar impact on the mortgage market as a whole-- by increasing lender confidence and encouraging lenders to provide more home loans (on better terms) to average Americans.
Fannie Mae and Freddie Mac Loans vs. FHA Loans
Specifically, when it comes to the borrower, Freddie Mac and Fannie Mae-eligible loans have a slightly higher minimum credit score requirement, at 620, than FHA loans, which permit borrowers with credit scores as low as 500 (though borrowers must have a score of at least 580 to qualify for the FHA’s popular 3.5% down payment program). All three organizations also permit borrowers without a credit score to establish what’s called a nontraditional credit profile-- which could consist of utility bills, rent payments, and other types of financial documents that prove a borrower has the ability to consistently make payments on time and in full. However, it may be considerably more difficult to get approved by a lender without a traditional credit score.
So, if you have sufficient credit, just how much can you borrow with a Freddie Mac or Fannie Mae loan? Or, for that matter, an FHA loan? Both Freddie Mac and Fannie Mae-guaranteed loans are subject to conforming loans limit set by the Federal Housing Finance Agency (FHFA). Right now (2019), the conforming loan limit for a one-unit property is $484,350 in most of the U.S., however, in high-cost areas, like Alaska, Guam, Hawaii, and the U.S. Virgin Islands, the limit for one-unit properties goes up to $726,525. In contrast, 4-unit properties in most of the U.S. have a limit of $931,600, while in high-cost areas, that limit goes up to $1,397,400.
Just like Fannie Mae and Freddie Mac loans, FHA loans are subject to local limits and high-cost areas-- but, in practice, they work a little bit different. For instance, the minimum FHA loan limit in most parts of the U.S. is currently $294,515, however, as of 2019, the maximum loan limit for high-cost areas is $726,525, the same as for Fannie Mae and Freddie Mac loans.
Also, while FHA loans require borrowers to pay a one-time, upfront, and annual, recurring mortgage insurance premium (MIP), which is typically 1.75% for the one-time charge and 0.85% for the annual charge, Fannie Mae and Freddie Mac loans typically require borrowers to get private mortgage insurance (PMI). This is beneficial to borrowers, as they usually will not have to pay any kind of upfront charge, and can ask their lender to cancel their PMI when they acquire 20% equity in their home. By law, lenders must cancel PMI once a borrower reaches 22% home equity. However, no matter how much equity an FHA loan borrower has their home, if they started their loan out paying MIP (meaning they put down less than 20% on their home), they will have to continue to pay it for the remainder of their mortgage-- unless they decide to refinance.
Fannie Mae vs. Freddie Mac Down Payment Requirements
While we just touched on the maximum loan amounts for Fannie Mae and Freddie Mac loans, as well as the mortgage insurance requirements-- we haven’t yet talked about down payments-- which could very well be the most stressful part of the borrowing process (at least for some). Fannie Mae is very well known for offering loans with down payments as little as 3%-- but that doesn’t necessarily mean that you’ll qualify. The Conventional 97 Loan is Fannie Mae’s most popular 3% down program-- but to qualify, you will need to be purchasing a one-unit primary residence, and, in practice, will often need to have a credit score of at least 680 (though the technical minimum is still 620). Plus, at least one borrower must qualify as a first-time homeowner. There are other requirements, too, but these are the main ones.
Another type of Fannie Mae loan offering a 3% down payment is the HomeReady mortgage, which is specifically intended for borrowers who live in low income or minority areas. Borrowers do not need to be first-time homeowners, but they must not own any other residential property in the U.S. Borrowers can use income from tenants and family members to in order to qualify, but there are actually no maximum income limits for HomeReady mortgages.
Freddie Mac also offers 3% down home loans through its HomePossible mortgage program, which is designed specifically for lower-income individuals. Borrowers are permitted to take out a HomePossible mortgage on a 1-4 unit property but must make no more than 100% of the area median income (AMI). However, there are no income limits if a borrower lives in a designated low-income area.
HomeOne is another type of 3% down Freddie Mac loan intended to serve the needs of first-time homeowners. Unlike the HomePossible mortgage program, there are no geographic or income limits. However, borrowers are restricted to taking out fixed-rate loans on one-unit properties.
Borrowers who do not qualify for a 3% down payment on a Fannie Mae or Freddie Mac loan will typically have to put 5% down, though they may be required to put 10% down. Just to compare, FHA loans have a universal 3.5% down payment requirement (for borrowers with a 580 credit score or above). Borrowers with a score of between 500-580 typically have to put 10% down.
Fannie Mae, Freddie Mac Loans, and FHA Loans for Home Renovation
In addition to guaranteeing ordinary, run-of-the-mill home loans, both Fannie Mae and Freddie Mac (as well as the FHA) guarantee home purchase/refinancing and renovation loans. For instance, the Fannie Mae HomeStyle loan allows borrowers to take out extra funds to complete a home renovation. It’s somewhat similar in nature to the FHA’s 203(k) loan for home purchase and renovation, but unlike the 203(k), it allows borrowers to finance a much wider variety of renovations, including luxury renovations.
In contrast, the 203(k) limits borrowers to a list of specific renovations, which some people may find limiting. Plus, the HomeStyle loan can be used for second homes, vacation homes, and investment properties, while the FHA 203(k) loan may only be used for primary residences. Finally, since the HomeStyle loan is a conventional mortgage, it does not require a mortgage insurance premium (MIP), and instead only requires that borrowers pay private mortgage insurance (PMI). However, since the 203(k) loan is insured by the Federal Housing Administration (FHA), it requires borrowers to pay both upfront and annual MIP.
Freddie Mac also offers home purchase/refinancing and renovation loans, though this program is significantly less popular than either the 203(k) or the HomeStyle renovation loan. Like Fannie Mae renovation loans, Freddie Mac renovation mortgages are available for both second homes/vacation homes and investment properties, in addition to primary residences. All three types of renovation loans are available for properties between one and four units-- however, for both Fannie Mae and FHA loans, properties between 2-4 units must be owner-occupied. In contrast, Freddie Mac renovation loans do not require that 2-4 unit properties be owner-occupied.
Fannie Mae vs. Freddie Mac: In Conclusion
In conclusion, both Fannie Mae and Freddie Mac offer a variety of great options for homeowners looking to get a mortgage. While they aren’t lenders and don’t offer mortgage insurance (like the FHA does), the fact that they’re willing to buy so many mortgages from lenders increases confidence in the market and makes it much easier for average Americans to get the home financing they need.