When you apply for a mortgage, you may hear names thrown around that include Fannie Mae, Freddie Mac, and HUD. Just what do they mean and how do they affect your mortgage? Keep reading to find out.
Who are Fannie, Freddie, and HUD?
In simple terms, Fannie, Freddie, and HUD are all government agencies that ‘back’ the mortgages lenders write. They don’t do the underwriting or funding of the loans. Instead, they set the guidelines that lenders must follow.
Fannie Mae and Freddie Mac actually purchase the loans written in their names (conventional loans). HUD, which guarantees FHA loans, doesn’t purchase the loans, but rather insures them. In other words, if the borrower defaults on an FHA loan, HUD pays the lender back a portion of the money they lost.
Looking at Fannie Mae and Freddie Mac
Fannie Mae and Freddie Mac both buy conventional loans, but they have different guidelines. Each entity caters to a different type of borrower.
First let’s look at the basics. You get a loan from a lender that follows Fannie or Freddie guidelines. Fannie or Freddie then buy the home from the lender. Fannie and Freddie then sell either the entire mortgage or the interest as mortgage-backed securities to the secondary market. This is what keeps investment money cycling through and keeps banks in the business of writing mortgages.
So both Fannie and Freddie buy mortgages, but only low-risk mortgages, which is why it’s harder to qualify for a conventional loan.
Typically, you need great credit, a low debt ratio, at least 5% down payment and a term that doesn’t extend past 30 years. Fannie and Freddie also have a loan limit, which is $484,350 currently. If you don’t meet the Fannie or Freddie guidelines, there are still government-backed options, including FHA loans.
How Fannie and Freddie Help Lenders
When Fannie Mae and Freddie Mac buy the loans from lenders, they give lenders less debt. In other words, they give lenders more money to lend to others. If the banks were to keep the loans on their own books, they’d eventually run out of money. This means they would have to stop writing loans. Instead, Fannie and Freddie help them keep things liquid by continually buying the loans that meet their guidelines.
By Fannie and Freddie buying loans, they increase the market’s stability. If banks had to stop writing loans, it would put a halt to the housing industry, which would greatly hurt the economy. Fannie and Freddie keep things going by filtering through the cycle of buying and selling mortgages.
Looking at HUD
Unlike Fannie Mae and Freddie Mac, HUD doesn’t buy FHA loans. Instead, it guarantees them. In other words, it provides insurance that borrowers pay that protects lenders. If the borrower stops making payments, HUD pays the lender with the insurance proceeds.
Like Fannie and Freddie, HUD or FHA has specific guidelines. Borrowers need at least:
- 580 credit score
- 5% down payment
- 31% housing ratio
- 41% total debt ratio
- Stable income and employment
- Proof that you’ll live in the home
- No defaulted federal debt
HUD helps lenders stay liquid by providing the insurance protection. If you default, the lender still earns money, which allows them to stay in the business of writing FHA loans.
FHA loans have more flexible guidelines than conventional loans, but that’s why you pay mortgage insurance for the life of the loan. In fact, the FHA charges an upfront funding fee plus annual mortgage insurance. Conventional loans, on the other hand, only charge Private Mortgage Insurance if you borrow more than 80% of the home’s value.
Explore all of your options when shopping for a home loan. Fannie and Freddie offer great programs, but not everyone qualifies. If you don’t, consider an FHA loan with its flexible guidelines and low rates, it offers a great way to buy your dream home.