Selling loans on the secondary market gives lenders the chance to free up their capital for more originations. In turn, they can scale up their businesses and boost their profits. However, not all loans qualify for secondary market participation and even some that do can result in repurchase demands or buy-backs if you don’t adhere to the investor’s requirements.
So, how can you ensure that your loans meet investors’ requirements for the secondary market?
In this article, we’ll explain how the secondary market works. We’ll also offer five tips to enhance the purchasability of your loans, prevent repurchase demands, and protect against mortgage fraud.
What is the Secondary Loan Market?
The secondary loan market is where mortgages are bought and sold after they’re originated.
Lenders can sell their loans on the secondary market to government-sponsored entities (GSEs), such as Fannie Mae and Freddie Mac, and other private investors.
After moving some loans off their balance sheets, lenders can use the extra capital to finance more loans. In some cases, they can also service the loans they’ve sold to earn ongoing revenue.
The History of Freddie Mac and Fannie Mae
Before the secondary market, the mortgage market was much more constricted. Most small-to-medium-sized lenders couldn’t originate many loans, since their capital was tied up for such long periods of time. As a result, most mortgages came with:[i]
- High down payments (as high as 50 percent)
- Short loan terms (one to seven years, on average)
- High interest rates
To make mortgages more affordable, Congress formed Fannie Mae in 1938 and Freddie Mac in 1970.[ii] According to the Federal Housing Finance Agency (FHA), the purpose of Fannie Mae and Freddie Mac is to provide “liquidity, stability, and affordability to the mortgage market.”[iii]
Fannie Mae and Freddie Mac bundle some of the loans they buy into mortgage-backed securities (MBSs). Investors can then purchase these MBSs and enjoy steady returns from the monthly mortgage interest rate payments.
To protect investors’ interests, Fannie Mae and Freddie Mac have strict standards for the loans they purchase. They only accept loans for creditworthy borrowers who have been thoroughly vetted during the underwriting process.
What Are Fannie Mae and Freddie Mac’s Requirements?
Fannie Mae and Freddie Mac have similar home loan guidelines. Their guidelines set standards for the following loan features:
- Loan size – The FHFA sets loan limits that apply to all loans delivered to Fannie Mae or Freddie Mac. For instance, this year, the single-unit property loan limits are $726,200 in standard locations and $1,089,300 in high-cost areas.[iv]
- Loan-to-value (LTV) ratio – The LTV ratio compares the size of the loan to the value of the property being purchased. Fannie Mae’s LTV requirements range from 65% to 97%, depending on the loan and property type.[v] For more details on Fannie Mae’s LTV requirements, check out their Eligibility Matrix.
- Credit score – Most Fannie Mae and Freddie Mac loans require borrowers to have a credit score of at least 680, though some loans require credit scores as high as 720.[vi]
- Debt-to-income ratio (DTI) – Fannie Mae typically only accepts manually underwritten loans for borrowers with DTIs of 36% or less, though borrowers who meet certain credit score and reserve requirements may be approved with DTIs up to 45%. For loans underwritten using Desktop Underwriting (DU), Fannie Mae allows DTIs of up to 50%.[vii]
- Down payment amount – Fannie Mae and Freddie Mac require private mortgage insurance (PMI) for any loans with down payments of less than 20%.[viii]
- Verification of employment – The purpose of mortgage employment verification is to ensure borrowers have stable jobs so they can make their mortgage payments on time. To meet Fannie Mae’s selling guidelines, borrowers must have a history of two years of employment income.[ix] Exceptions may be made if a borrower’s current income is deemed impressive enough to offset their limited employment history.
Lenders must also obtain a verbal verification of borrowers’ employment from their employer within 10 business days of their employment income note date.[x]
These are just a few of the requirements lenders must adhere to enjoy the opportunity to sell their loans on the secondary market. Since so many lenders want this opportunity, Fannie Mae and Freddie Mac’s requirements drive many lenders’ underwriting decisions today.
How Can You Ensure Your Loan Meets Investor Requirements
Now that you have a little background on Fannie Mae and Freddie Mac, let’s take a look at the best practices for improving the Loan Quality Initiative (LQI) compliance of your loans to be purchasable on the secondary market and reduce the risk of buy-backs.
#1 Employ Comprehensive Credit Checks
The only way to know if an applicant meets Fannie Mae and Freddie Mac’s credit criteria is to review their credit history thoroughly.
With Certified Credit’s customizable credit reports, evaluating your applicants’ credit history efficiently is a breeze. We enable you to order your credit reports’ content so you can see the most important information first.
In addition to reviewing your applicants’ credit reports on your own, you may also want to sit them down and look through their reports with them line-by-line. During this process, an applicant may discover a credit reporting error and file a timely dispute.
#2 Ensure Proper Verifications
Next, you must verify your applicants’ income and employment history. You can make this process easier by automating it with Cascade Verification of Income and Employment (VOE).
This innovative solution automates the VOE process. All you have to do is select your custom cascade of third-party, consumer-permissioned, and manual vendors and arrange them in your preferred order. After that, Cascade VOE can take care of the rest, promptly alerting you as soon as it returns a hit.
You should also conduct a timely verbal VOE near closing. While Fannie Mae’s guidelines allow you to complete this process within 10 days of closing, however doing it on the day of is a much safer bet. After all, your applicant could lose their job or change their payment structure at any point in the origination process without informing you.
The best way to conduct verbal VOE is to find the phone number of your applicant’s employer and reach out to them or their human resources representative directly. This way, you can get the verification straight from the source and bolster your mortgage fraud prevention and mitigate the risk or repurchase demands.
#3 Reduce Repurchase Demands With Undisclosed Debt Monitoring
During the initial application process, you may confidently approve an applicant after ensuring they meet all of Fannie Mae and Freddie Mac’s selling standards. Unfortunately, their eligibility criteria may be subject to change during the origination process.
For instance, a borrower may take out additional debt before closing to purchase a new vehicle or furniture for their new home. This debt may boost their DTI past the acceptable level.
According to Jillian Sorensen, Vice President and Account Executive at Flagstar Bank, 50% of all repurchase demands are related to undisclosed debt. The majority of the remaining are due to changes in employment.
If a loan no longer qualifies with Fannie Mae or Freddie Mac, you may have to buy it back from them on the spot. Not only can repurchase demands burden your team’s workloads, but they can also have serious financial consequences for your company.
You can prevent undisclosed debt from derailing your loan sales by:
- Using undisclosed debt monitoring (UDM) – UDM solutions, like Cascade UDM, can monitor your applicants’ credit reports from the initial credit pull through closing and beyond. If an applicant’s credit report receives new data during the origination process, such as a large debt balance or missed loan payment, you’ll be alerted within 24 hours. Receiving these prompt notifications can give you and your team the notice you need to get your applicant back on track before closing.
- Running a Credit Refresh report – Alternatively, you can run a quick Credit Refresh report on the day of closing. This soft pull credit report can show you if your applicant has incurred any noteworthy changes to their credit report since your initial credit pull.If they have, you may discover that the loan no longer qualifies for sale on the secondary loan market or requires new terms or conditions. Unfortunately, Credit Refresh reports give you little time to remedy the situation. That’s why UDM is quickly eclipsing Credit Refresh reports as lenders’ preferred mortgage LQI tool.
#4 Brush Up On The New Loan-Level Price Adjustments
If you’re not careful, Loan-Level Price Adjustments (LLPA) can increase the cost of your loans considerably. In turn, it’s important to understand the latest changes issued by Fannie Mae.
On January 19th, 2023, Fannie Mae announced a new Loan-Level Price Adjustment (LLPA) framework.[xi] This framework outlines the point adjustments required for loans based on their:
- Credit scores
- Property attributes
- LTV ranges
The changes outlined in this framework will take effect starting May 1, 2023. One of the most notable changes is that all loans will be assessed a quarter point if their DTI is above 40%. Thus, monitoring applicants’ DTIs throughout the origination process is more important than ever.
An applicant with a 39% DTI could easily exceed that 40% threshold if they incur any new debt before closing, leaving you on the line for that quarter-point increase. Since margins are so tight in today’s market, you want to avoid this outcome whenever possible.
#5 Educate Your Borrowers on Undisclosed Debt Early On
Since undisclosed debt can disrupt so many aspects of your secondary market participation, it’s a good idea to teach your borrowers about its consequences at the very beginning of your lending relationship.
Many borrowers may not know that opening a new credit card or changing jobs before closing could put their mortgage loan at risk. Giving them the heads-up can protect both of your best interests.
Strengthen Your Loans’ Sellability With Certified Credit
As you can see, originating sellable loans is an involved process. Fortunately, it’s made easier when you have the right tools.
Here at Certified Credit, our mortgage lending solutions can help you vet your applicants thoroughly with ease. By automating your workflows, you can also free up your time and use it to educate borrowers and provide them with excellent customer service.
In addition to Cascade UDM and Cascade VOE, we offer:
- Affordable tri-merge credit reports
- Automated borrower retention and lead generation tools
- Automated prequalification
- Credit score improvement tools
- Flood zone determinations
- Fraud and risk support
- Settlement services
If you want to find out how Certified Credit can strengthen your position in the secondary market, schedule a credit consultation with our team today.
[i] AmericanProgress.org. 7 Things You Need to Know About Fannie Mae and Freddie Mac.
[ii] Bankrate. Demystifying the secondary mortgage market.
[iii] FHFA. Fannie Mae and Freddie Mac.
[iv] FHFA. FHFA Announces Conforming Loan Limit Values for 2023.
[v] Fannie Mae. Eligibility Matrix.
[vi] Fannie Mae. Eligibility Matrix.
[vii] Fannie Mae. What is the maximum DTI ratio allowed?
[viii] Nerd Wallet. What Is Mortgage Insurance? How It Works, When It’s Required.
[ix] Fannie Mae. Is there a minimum length of employment history required for base pay?
[x] Fannie Mae. B3-3.1-07, Verbal Verification of Employment (08/03/2022).
[xi] Fannie Mae. Lender Letter (LL-2023-01).