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Freddie Mac, Fannie Mae and FHA Loans: Which Is Better?

tl;dr

What You Need To Know

  • Fannie Mae and Freddie Mac, under the direction of the Federal Housing Finance Agency (FHFA), help set the standards for conventional loans, and the Federal Housing Administration (FHA) sets the standards for government-backed loans
  • Compared to conventional loans from Fannie Mae and Freddie Mac, FHA loans have more lenient credit score and debt-to-income (DTI) ratio requirements
  • Fannie Mae and Freddie Mac allow borrowers to buy a home with as little as 3% down

Contents

When you’re looking for a mortgage, you’ll hear a lot of F-words thrown around, like Fannie and Freddie and FHA. And it can get pretty confusing.

If you’re interested in buying a home, knowing these acronyms and what they do will help – especially if you’re a first-time home buyer or have less-than-ideal credit.

Here are the names to know:

  • Federal National Mortgage Association (FNMA or Fannie Mae) 
  • Federal Home Loan Mortgage Corporation (FHLMC or Freddie Mac)
  • Federal Housing Administration (FHA)
  • Federal Housing Finance Agency (FHFA)

Fannie Mae and Freddie Mac do the same thing for different types of lenders, so they are often grouped and referred to as Fannie and Freddie.

So, why do Fannie Mae, Freddie Mac and the FHA matter? Well, all three organizations play a role in setting the standards lenders use to decide if you qualify for a mortgage and how much your monthly payment will be. This includes:

  • Credit score: A score ranging from 300 – 850 that measures your creditworthiness (the higher your score, the better!).
  • Debt-to-income (DTI) ratio: Your recurring, monthly debts divided by your gross monthly income.
  • Loan limit: How much money you can borrow.
  • Minimum down payment: How much you need to put down on a home (which is a percentage of the home sale price) to qualify for a mortgage.
  • Mortgage insurance: Monthly and/or upfront fees or premiums you pay depending on your home’s loan-to-value (LTV) ratio (your loan divided by the sale price or appraised value of the home) and type of loan.
  • Types of properties you can buy: The list of eligible properties you can buy, including a second home or investment property.
  • Income requirements: Income ranges you must meet to qualify for a mortgage. 

Who Are Fannie Mae and Freddie Mac?

Fannie Mae and Freddie Mac aren’t government agencies. Both are private corporations that were chartered by the federal government and are supervised by the federal government to this day. 

What do Fannie and Freddie do?

Their role is to make mortgages more affordable. They do this by buying mortgages from banks and other approved lenders and packaging them as mortgage-backed securities (aka mortgage-backed bonds).

When Fannie or Freddie buys a lender’s mortgages, it gives the lender the capital (read: cash) they need to offer more home loans to more home buyers.

While this is strictly controlled, it also makes them big players in the financial market as well as the mortgage market. How big? They currently rank in the Forbes 500 top 10 financial sector firms and top 50 overall.[1]

Why do Fannie and Freddie matter? 

Conventional loans (aka conforming loans or conventional conforming loans) are the most popular type of mortgage loan out there. 

Because lenders want to sell their loans to Fannie and Freddie, conventional loans “conform” to the standards and guidelines set by Fannie Mae and Freddie Mac. (The majority of U.S. mortgages are designed to meet these standards.) 

Loans that don’t meet Fannie or Freddie’s standards (such as a jumbo loan) are considered nonconforming loans. 

Fannie Mae and Freddie Mac mortgage standards[2][3][4][5]

Minimum Credit Score 620
Minimum Down Payment 20% standard (as low as 3% with some loans)
Loan LimitsBetween $548,250 – $822,375 (based on area)
Preferred DTI36% or lower
Maximum DTI 50%
Mortgage InsurancePrivate mortgage insurance (PMI) for loans with less than 20% down 
Mortgage Insurance CostPay between 0.2% and 2% of a loan’s annual value until you reach 78% LTV
Eligible PropertiesPrimary residence, second home, investment or rental properties
Income Requirements2 years of income preferred (can be waived at lender’s discretion)

What Is the Federal Housing Administration (FHA)?

The FHA was created during the Great Depression to insure and regulate the U.S. mortgage industry and make it easier for homeowners to afford mortgages. 

In 1965, the FHA became a part of the newly formed Department of Housing and Urban Development (HUD), which was tasked with expanding homeownership opportunities for all Americans.

What does the FHA do?

The FHA doesn’t directly lend you money. Instead, the FHA backs (read: insures) loans made by lenders. While there are no specific income limits for FHA loans, they’re usually aimed at first-time home buyers and home buyers who might not qualify for a mortgage because of income or past credit issues.

Why does the FHA matter?

Because the agency backs these loans, essentially promising to cover them in case a borrower defaults, lenders can make these loans available to borrowers who usually wouldn’t have qualified for a conventional loan. The FHA also sets the standards for the loans they back.

FHA mortgage standards[6][7][8][9]

Minimum Credit Score 580 or higher with 96.5% (3.5% down) or 500 – 579 with 90% LTV (10% down)
Minimum Down Payment 3.5% down
Loan LimitsBetween $356,362 – $822,375 (based on area)
Preferred DTI43% or lower
Maximum DTI 57%
Mortgage InsuranceMortgage insurance premiums (MIPs) required for all loans
Mortgage Insurance CostPay 1.75% of loan value upfront and 0.45% – 1.05% of annual loan value (based on LTV and loan terms) for 11 years or the life of the loan
Eligible PropertiesPrimary residence only
Income Requirements2 years income required

Fannie Mae and Freddie Mac vs. FHA: Then and Now

Traditionally, a conventional loan from Fannie Mae or Freddie Mac was seen as preferable. Some of that was due to the stigma of FHA loans being “government-backed” and the slightly higher interest rates and more expensive mortgage insurance requirements that came with those loans. 

After the Great Recession, that perspective changed as homeowners began to refinance their mortgages through the FHA.[10]

In recent years, the differences between a Fannie Mae loan or a Freddie Mac loan or an FHA loan have become less obvious.

To keep up with the economic challenges facing new home buyers, Fannie Mae currently offers a HomeReady® mortgage program[11] and Freddie Mac offers a Home Possible® program.[12]

Both allow home buyers to qualify for a conventional mortgage with lower incomes and as little as 3% down, without having to pay long-term MIP.

But even the most generous Fannie Mae and Freddie Mac programs still require a 620 credit score. If your score is lower than 620, the FHA may be your best option.

Fannie Mae and Freddie Mac vs. FHA: Which Is Right for You?

In the end, you and your lender will have to decide if a conventional loan backed by Fannie or Freddie or a loan backed by the FHA will be the right choice for you and your financial situation.

Be sure to ask lenders about both financing options.

  1. Fortune. “Ranking of Top 500 Global Companies – Filtered for Financial Sector.” Retrieved October 2021 from https://fortune.com/fortune500/2021/search/?sector=Financials

  2. Federal Housing Finance Agency. “FHFA Announces Conforming Loan Limits for 2021.” Retrieved October 2021 from https://www.fhfa.gov/Media/PublicAffairs/Pages/FHFA-Announces-Conforming-Loan-Limits-for-2021.aspx

  3. Fannie Mae. “Selling Guide – B3-6-02, Debt-to-Income Ratios (02/05/2020).” Retrieved October 2021 from https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-6-Liability-Assessment/1032992131/B3-6-02-Debt-to-Income-Ratios-02-05-2020.htm#DTI.20Ratios

  4. Fannie Mae. “ELIGIBILITY MATRIX.” Retrieved October 2021 from https://singlefamily.fanniemae.com/media/20786/display

  5. Experian™. “How Much Does Private Mortgage Insurance (PMI) Cost?” Retrieved October 2021 from https://www.experian.com/blogs/ask-experian/how-much-does-private-mortgage-insurance-pmi-cost/

  6. U.S. Department of Housing and Urban Development. “Section C. Borrower Credit Analysis Overview.” Retrieved October 2021 from https://www.hud.gov/sites/documents/4155-1_4_SECC.PDF

  7. U.S. Department of Housing and Urban Development. “Maximum Mortgage Limits 2021.” Retrieved October 2021 from https://www.hud.gov/program_offices/housing/sfh/lender/origination/mortgage_limits

  8. Federal Deposit Insurance Corporation. “203(b) Mortgage Insurance Program.” October 2021 from https://www.fdic.gov/consumers/community/mortgagelending/guide/part-1-docs/203b-mortgage-insurance-program.pdf

  9. U.S. Department of Housing and Urban Development. “APPENDIX 1.0 – MORTGAGE INSURANCE PREMIUMS.” Retrieved October 2021 from https://www.hud.gov/sites/documents/15-01MLATCH.PDF

  10. Federal Housing Finance Agency. “National Mortgage Database (NMDB) Aggregate Data.” Retrieved October 2021 from https://www.fhfa.gov/DataTools/Downloads/Pages/National-Mortgage-Database-Aggregate-Data.aspx

  11. Fannie Mae. “HomeReady Mortgage.” Retrieved October 2021 from https://singlefamily.fanniemae.com/originating-underwriting/mortgage-products/homeready-mortgage

  12. Freddie Mac. “Home Possible®.” Retrieved October 2021 from https://sf.freddiemac.com/working-with-us/origination-underwriting/mortgage-products/home-possible

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In Case You Missed It

Take-aways

  1. Fannie Mae and the FHA were created in response to the Great Depression
  2. Fannie Mae and Freddie Mac don’t offer loans directly. They buy mortgages from other lenders and financial institutions and sell them as mortgage-backed securities
  3. It’s easier to get approved for an FHA loan, but you pay higher costs and pay for mortgage insurance over a longer time than you would with a conventional loan

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