How Do Fannie Mae and Freddie Mac Loans Work?

How Do Fannie Mae and Freddie Mac Loans Work? article image.

When you're shopping for a mortgage, you come across a lot of terminology that may be unfamiliar. Two terms you often encounter are Fannie Mae and Freddie Mac. But what are Fannie Mae and Freddie Mac, and what do they have to do with mortgage loans?

Fannie Mae and Freddie Mac sound like they might be the names of your favorite aunt and uncle, but they're actually two major buyers and sellers of home mortgage loans. That means they buy loans from banks, bundle them together and then sell them to investors. The money banks gain from selling these loan sales enables them to lend more money to homebuyers.

Because Fannie Mae and Freddie Mac want to make sure the loans that they buy can be sold, these two federally backed companies set certain lending standards for borrowers. The loans that adhere to those standards are known as conforming loans. Follow along to find out more about how Fannie Mae and Freddie Mac loans work.

Fannie Mae vs. Freddie Mac Loans
Fannie Mae LoansFreddie Mac Loans
Purchased from big banksPurchased from small banks
Debt-to-income ratio up to 50%Debt-to-income ratio up to 45%
Minimum credit score of 620Minimum credit score of 620

How Do Fannie Mae Loans Work?

Fannie Mae, or the Federal National Mortgage Association, buys conventional loans from big banks. Fannie Mae requires those banks to follow certain guidelines for lending money to homebuyers. These guidelines help ensure that Fannie Mae can sell these loans to investors. They include:

  • Debt-to-income ratio up to 50%
  • Credit score of at least 620
  • Down payment of at least 3% of the home's purchase price—the 3% payment applies to HomeReady loans, geared to buyers who have low income or have limited cash for a down payment
  • Private mortgage insurance (PMI) is typically required when down payment is less than 20% of home purchase price

How Do Freddie Mac Loans Work?

Freddie Mac, or the Federal Home Loan Mortgage Corporation, buys conventional loans from small banks. These are the guidelines that Freddie Mac establish for loans:

  • Debt-to-income ratio up to 45%, although 33% to 36% is recommended
  • Credit score of at least 620
  • Down payment as low as 3% of purchase price for HomeOne loans, geared toward first-time buyers, and as low as 3% for Home Possible loans, designed for people such as first-time buyers, low-income borrowers and retirees
  • PMI typically required when the homebuyer puts down less than 20% of home's purchase price

Why Do Fannie Mae and Freddie Mac Loans Exist?

Fannie Mae and Freddie Mac were both created by Congress. And while they don't lend directly to homebuyers, they still play an important role in financing home loans. By purchasing mortgages and selling them to investors, Fannie Mae and Freddie Mac free up cash for banks, mortgage companies and other lenders to finance home purchases. This also helps keep down interest rates and stabilizes the lending market.

Fannie Mae was established in 1938 and Freddie Mac in 1970. They're structured so that the federal government guarantees they won't default on their debt.

Amid the COVID-19 pandemic, American homeowners with Fannie Mae or Freddie Mac loans have been able to take advantage of potential financial relief if they were struggling to make their mortgage payments. Relief options include reduction of monthly payments or creation of a repayment plan.

Alternatives to Fannie Mae and Freddie Mac Loans

If a Fannie Mae- or Freddie Mac-conforming loan doesn't work out, you do have other options. Here are four of them.

  1. FHA loans: FHA loans, backed by the Federal Housing Administration (FHA), offer low down payment options (at least 3.5%) and low minimum credit score requirements (as low as 500 if you can provide a 10% down payment).
  2. VA loans: VA loans, backed by the U.S. Department of Veterans Affairs, are available to active-duty members of the military, military veterans and surviving spouses.
  3. USDA loans: Mortgage loans offered through the U.S. Department of Agriculture (USDA) are designed for low- and moderate-income borrowers in rural areas.
  4. Jumbo loans: A jumbo mortgage exceeds the borrowing limits set by Fannie Mae and Freddie Mac for a conventional loan. In most of the U.S., the borrowing limit for 2021 is $548,250. In high-cost regions, the limit for 2021 is $822,375.

The Bottom Line

Before you apply for a Fannie Mae or Freddie Mac loan or any other mortgage, it's wise to get your finances in order. This includes obtaining your free Experian credit score and free Experian credit report to see where your credit stands.