Most lenders would consider a conventional mortgage as a loan that conforms to the guidelines set forth by Freddie Mac and Fannie Mae, the two government sponsored enterprises (GSEs) that provide liquidity in the mortgage market.
Technically speaking, a conventional loan is any mortgage that is not guaranteed or insured by the U.S. government, such as VA, FHA and USDA.
Conventional mortgages include portfolio loans, construction loans and even subprime loans. Again, whenever a lender refers to a "conventional loan," they are most likely referring to conforming mortgages that are eligible for purchase by Fannie Mae and/or Freddie Mac.
Fannie Mae and Freddie Mac are publicly traded companies and Government Sponsored Enterprises (GSEs) and are the largest source of mortgage money in the United States. Fannie Mae was originally introduced as part of President Roosevelt's New Deal, but was later privatized in 1968. Freddie Mac, often referred to as Fannie Mae's younger brother, was created in 1970. The sole purpose of the two agencies is to securitize mortgages and provide liquidity in the mortgage markets.
Why Securitize Mortgages?
The process of securitizing mortgage loans and selling them on the secondary market allows banks to continue writing loans for real estate.
For Example: If you were to go to your favorite lender and were approved for a mortgage loan of $250,000, they would have to provide the funds necessary to complete the transaction, while receiving a payment each month for the next 30 years until the loan was paid off. If the bank tied up their money for 30 years, they'd eventually run out of cash to lend on properties, auto loans, credit cards, etc. Fannie and Freddie provide that liquidity needed by purchasing the mortgages, bundling them with thousands of other similar loans and selling them as bonds on the mortgage backed securities market.
What Type of Mortgages Do Fannie Mae and Freddie Mac Purchase?
1. The mortgage must meet the conforming loan limit, which is evaluated each year
2. Loans with borrowers must meet minimum credit score
3. Loans that meet the GSE guidelines in regards to debt-to-income ratios
4. Private Mortgage Insurance (PMI) is required for all loans where the borrower has less than 20% equity in the subject property
5. Several more guidelines
It is important to understand that neither Fannie Mae, nor Freddie Mac service the loans they purchase. These companies purchase loans from various lenders, and those lenders retain (keep) the servicing.
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