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The Role of Fannie Mae and Freddie Mac in Mortgage Lending

Fannie Mae and Freddie Mac are government-sponsored enterprises that purchase mortgages from lenders and guarantee mortgage-backed securities, providing the liquidity that enables continuous mortgage lending. Their published guidelines define the standards for conforming loans, and their automated underwriting systems (DU and LP) evaluate loan applications. Under FHFA conservatorship since 2008, the GSEs guarantee approximately 60-70% of new single-family mortgages and directly influence mortgage rates through their pricing structures.

Key Takeaways

  • Fannie Mae and Freddie Mac do not make loans directly — they purchase conforming loans from lenders and guarantee mortgage-backed securities.
  • Their selling guides define the standards for conforming conventional loans, including credit, income, property, and documentation requirements.
  • Conforming loan limits are set annually by FHFA; loans exceeding these limits are classified as jumbo and cannot be purchased by the GSEs.
  • Desktop Underwriter (Fannie Mae) and Loan Product Advisor (Freddie Mac) are automated underwriting systems that evaluate applications and drive documentation requirements.
  • Loan-Level Price Adjustments (LLPAs) increase costs for higher-risk loan characteristics such as lower credit scores, higher LTVs, and investment properties.
  • The GSE guarantee on mortgage-backed securities is the primary reason conforming rates are lower than jumbo rates.
  • Both GSEs have been under FHFA conservatorship since 2008, with ongoing policy debate about their future structure.
  • Lender overlays are additional restrictions above and beyond GSE minimums that individual lenders choose to impose.

How It Works

GSE Charter and Purpose

Congress created Fannie Mae in 1938 and Freddie Mac in 1970 to promote stability, liquidity, and affordability in the housing market. Their charter mandate includes supporting a continuous flow of mortgage funds, reducing the cost of housing finance, and promoting access to mortgage credit across the country, including in underserved markets. The GSEs accomplish this by providing a reliable secondary market for conforming mortgages, which reduces the risk for originators and enables more competitive interest rates for borrowers.

Conforming Loan Limits

The GSEs can only purchase loans that fall within conforming loan limits set annually by the Federal Housing Finance Agency (FHFA). For 2024, the baseline conforming loan limit for a single-family home is $766,550, with higher limits (up to $1,149,825) in designated high-cost areas. Loans exceeding these limits are classified as jumbo loans and are not eligible for GSE purchase, meaning they must be held in portfolio or sold through non-agency channels .

Selling Guides and Underwriting Standards

The Fannie Mae Selling Guide and the Freddie Mac Seller/Servicer Guide are comprehensive documents that establish the requirements for loans the GSEs will purchase. These guides cover every aspect of loan origination: borrower eligibility, income documentation and calculation, credit requirements, property eligibility and appraisal standards, maximum debt-to-income ratios, down payment and reserve requirements, and private mortgage insurance specifications. Lenders who want to sell loans to the GSEs must ensure their origination practices comply with these guidelines.

When a lender’s underwriting practices are more restrictive than the GSE minimums, the additional restrictions are called “overlays.” Overlays are at the lender’s discretion and may include higher minimum credit scores, lower maximum DTI ratios, or additional documentation requirements beyond what the GSE guidelines require.

Automated Underwriting Systems: DU and LP

Fannie Mae’s Desktop Underwriter (DU) and Freddie Mac’s Loan Product Advisor (LP, formerly Loan Prospector) are automated underwriting systems (AUS) that evaluate loan applications and issue recommendations. Lenders submit borrower data to these systems, which analyze the information against the respective GSE’s guidelines and return a finding: Approve/Eligible (DU) or Accept (LP) for loans that meet requirements, or Refer (requiring manual underwriting review) for those that do not pass the automated evaluation.

The AUS findings drive the documentation requirements for each loan. A strong DU Approve/Eligible may waive certain documentation requirements (such as tax transcripts or employment verification), while a weaker finding or a Refer requires full documentation and manual underwriter review .

Related topics include qualified mortgage (qm) rules explained, fair lending laws and equal credit opportunity, fha program structure and guidelines overview, appraisal independence requirements, and mortgage regulations: a borrower’s guide.

Key Factors

Factors relevant to The Role of Fannie Mae and Freddie Mac in Mortgage Lending
Factor Description Typical Range
Conforming Loan Limits
Loan-Level Price Adjustments (LLPAs)
Automated Underwriting Findings
GSE Guarantee Fee

Examples

Scenario: Borrower obtaining a conforming conventional loan sold to Fannie Mae
Outcome: The lender funds the loan at closing, then sells it to Fannie Mae within 30-60 days. Fannie Mae pools the loan into an MBS and guarantees it. The borrower receives a competitive rate of approximately 6.5% because the GSE guarantee reduces investor risk. The lender retains servicing and collects payments on behalf of Fannie Mae.

Scenario: Borrower with a loan amount exceeding conforming limits (jumbo loan)
Outcome: The lender must hold the loan in portfolio or sell it through a non-agency (private-label) channel without GSE guarantee. The rate is approximately 0.25-0.50% higher than a conforming loan with the same borrower profile because investors demand a higher yield without the GSE guarantee. The lender may also impose stricter credit and reserve requirements.

Scenario: Impact of LLPAs on a borrower with a lower credit score
Outcome: Borrower A's LLPA for a 760 score at 90% LTV is approximately 0.50% in fee (equivalent to about 0.125% in rate). Borrower B's LLPA for a 660 score at 90% LTV is approximately 2.75% in fee (equivalent to about 0.75% in rate). Borrower B pays approximately $225 more per month on the same loan amount due to risk-based pricing adjustments.

Common Mistakes to Avoid

  • Assuming Fannie Mae and Freddie Mac are government agencies that make loans directly to borrowers
  • Not understanding that lender overlays can be more restrictive than published GSE guidelines
  • Ignoring LLPAs when comparing mortgage offers
  • Assuming conforming loan limits are the same everywhere
  • Overlooking the difference between DU and LP findings and their impact on documentation

Documents You May Need

  • Loan application (Uniform Residential Loan Application, Form 1003)
  • Income documentation (pay stubs, W-2s, tax returns) as specified by the AUS finding
  • Asset documentation (bank statements, investment account statements)
  • Credit report (pulled by the lender, analyzed by the AUS)
  • Property appraisal meeting GSE standards (unless waived by the AUS)
  • Title search and title insurance commitment
  • Private mortgage insurance certificate (for loans with LTV above 80%)
  • Verification of employment (may be waived depending on AUS finding)

Frequently Asked Questions

What is the difference between Fannie Mae and Freddie Mac?
Both are government-sponsored enterprises that buy mortgages and guarantee MBS. The main differences are their respective selling guides (which are similar but not identical), their automated underwriting systems (DU for Fannie Mae, LP for Freddie Mac), and some specific program offerings. For most borrowers, the practical differences are minimal.
How do Fannie Mae and Freddie Mac affect my mortgage rate?
Their guarantee on mortgage-backed securities reduces investor risk, which results in lower yields (and therefore lower rates) for conforming loans. Additionally, their LLPAs and guarantee fees are built into the rate. Stronger borrower profiles with lower LLPAs receive better rates.
What is a conforming loan?
A conforming loan meets the guidelines and loan limits established by Fannie Mae and Freddie Mac. The loan amount must be at or below the conforming limit for the area, and the borrower and property must meet the GSE's underwriting standards.
What happens to my loan after the lender sells it to Fannie Mae or Freddie Mac?
Your loan terms (rate, payment, balance) do not change. The GSE now owns the loan and bears the credit risk. Your servicer (the company you make payments to) may remain the same or may change. You will receive written notice of any servicing transfers.
Why do jumbo loans have higher rates than conforming loans?
Jumbo loans cannot be sold to the GSEs and therefore do not carry the GSE guarantee. Investors purchasing non-agency MBS or holding jumbo loans in portfolio demand a higher yield to compensate for the additional risk, which translates to higher rates for borrowers.
What are Loan-Level Price Adjustments?
LLPAs are risk-based fees that adjust the cost of a loan based on specific characteristics: credit score, LTV ratio, property type, occupancy type, and loan purpose. Higher-risk characteristics result in higher LLPAs, which increase the borrower's rate or closing costs.
What does it mean that Fannie Mae and Freddie Mac are in conservatorship?
Since 2008, the Federal Housing Finance Agency (FHFA) has overseen the GSEs under conservatorship, which gives FHFA control over their operations and policy decisions. This was established during the financial crisis and remains in effect. The conservatorship's future is subject to ongoing legislative and regulatory discussion.
Can my lender choose whether to sell my loan to Fannie Mae or Freddie Mac?
Yes. The lender decides which GSE to sell to based on which program offers better pricing or execution for the specific loan characteristics. Both GSEs have similar but not identical guidelines, and some loans may be eligible for one but not the other.
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