Understanding how loans work specifically related to real estate is very important whether you’re purchasing a home, investing directly in real estate, or trading mortgage backed securities (MBS). So this week, I’ll outline the basics of conventional financing and Fannie and Freddie. Next week we’ll look at nontraditional loans.
A conventional loan is a lender agreement that’s not guaranteed or insured by the VA (Veterans Administration), FHA (Federal Housing Administration), or RHA (Rural Housing Service). A conventional loan can, however, follow the guidelines to meet the funding criteria of Fannie Mae and Freddie Mac (more about them a little later). If a loan follows the guidelines set by Fannie and Freddie, it’s considered to be "conforming," whereas "non-conforming" loans don’t meet those qualifications but can still be conventional.
Conventional loans can have either fixed or adjustable rates. These loans also tend to carry the best interest rates and terms. There is another category of conventional loans known as Jumbo Loans. These loans fall outside of Fannie and Freddie maximum loan amounts and they usually carry higher interest rates.
A large majority of conventional loans that meet the guidelines are guaranteed or purchased by Fannie and Freddie.
Who are Fannie and Freddie? Good question.
Fannie Mae stands for Federal National Mortgage Association; it was created as a Government Sponsored Enterprise (also known as GSE). Fannie Mae was created back in 1938 to expand mortgage money by creating a secondary mortgage market. The secondary market that Fannie Mae created is the Mortgage Backed Securities (MBS) market. The market for Fannie Mae’s MBS’s has historically been extremely large and liquid containing pension funds, insurance companies and foreign governments among its largest investors. Fannie Mae was also created to concentrate its efforts into increasing the ability and affordability of homeownership for low, moderate and middle income Americans.
Freddie Mac stands for Federal Home Loan Mortgage Corporation. This was also created as a GSE chartered by Congress in 1970. Freddie Mac was created to keep money flowing to mortgage lenders in support of homeownership and rental housing for middle income Americans. It works similarly to Fannie Mae in that it guarantees and securitizes mortgages to form MBS’s.
Freddie Mac has been criticized because of its ties to the U.S. Government which allows it to borrow money at interest rates lower than those available by other financial institutions. It is believed that these portfolios have created a large risk to the system and the U.S. economy. This risk was clearly defined on September 7, 2008 when the U.S. Government took over both Fannie Mae and Freddie Mac, placing them in a conservatorship to help avert a financial system meltdown from the housing crisis.
In testimony before the House Financial Services Committee on June 3, 2009, Federal Housing Financial Agency Director James B. Lockhart III presented his report. In short, Mr. Lockhart said that the 200 billion dollars in capital given to each enterprise is expected to be sufficient at this time. The combined share of mortgages originated by Fannie and Freddie in the first quarter of 2009 was 73% of all mortgages. Both Fannie and Freddie are heavily involved in planning and implementing the Making Home Affordable and the Home Affordable Refinance Programs successful.
So what kind of loans programs are available through Fannie and Freddie?
Flexible Mortgages – enables the homeowner with good credit to obtain a high loan to value and minimum down payment. Where the borrower gets the money for the down payment is flexible such as from gifts or loans from family.
My Community Mortgage – this is for families with moderate to low income who have limited funds for closing and down payment. It also offers community servants such as police officers, firefighters, teachers, military members, and healthcare workers loans with a LTV (loan to value) of up to 97%.
Home Style Renovation - this loan helps people who buy a home that is in need of repairs, or are refinancing an existing home that needs repairs, and incorporate the repair loans into an existing mortgage. The loan is based on an "as completed quote" value rather than the unimproved present value.
Reverse Mortgages - are for people 62 years old and older. This is a home loan based on the equity of their home. The owner may borrow against the home equity and not have to pay the loan back as long as they remain in the home. The loan is helpful for seniors who are having difficulty keeping up with the cost of living expenses.
These are a variety of loan options to become familiar with. As an investor, it’s important to know what options are available for the end user when you go to sell the property. In the next issue, we’ll discuss Nontraditional loans.
- Diana Hill email@example.com