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- GSE stands for government-sponsored enterprise, a private entity created by Congress.
- A GSE home loan is a private mortgage loan that follows certain government regulations.
- GSE loans generally offer easier qualification, lower interest rates, and better terms than conventional loans.
The term government-sponsored enterprise (GSE) might not sound familiar, but chances are you or someone you know has dealt with a GSE entity or, more specifically, a GSE loan.
GSE loans make up more than half of first-time buyer mortgages because they are easier to qualify for, offer lower interest rates, and return capital to lenders.
What is a GSE?
A government-sponsored enterprise (GSE) is a private company created by Congress that offers important financial services to the public. GSEs facilitate lending, especially with regard to mortgages, and promote access to capital by providing advances to lenders, purchasing mortgage loans, and selling the loans to investors.
The most well-known GSEs, Fannie Mae and Freddie Mac, were chartered in 1938 and 1970, respectively. They purchase mortgages from lenders and sell them on secondary markets. Proceeds from the sale of these mortgages are used by lenders to extend more credit to borrowers.
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GSE vs. traditional mortgage lenders
Unlike traditional lenders, GSEs do not lend money directly to consumers. Instead, they extend credit to member lending institutions or stimulate lending by purchasing loans on the secondary market and selling them to investors. All of these mechanisms return capital to lenders, allowing them to make even more loans.
Federal Home Loan Banks (FHLB), which were chartered to extend credit through member banks, are allowed to extend advances and letters of credit for residential housing, small businesses, small farms, and small agribusinesses.
The Federal Agricultural Mortgage Association (Farmer Mac) buys up agricultural loans, resells them, and guarantees principal and interest on debt securities. Fannie Mae and Freddie Mac purchase loans from private lenders, package and resell them as mortgage securities, and thereby increase the amount of credit lenders have to extend to low- and moderate-income borrowers.
What is a GSE loan?
The term GSE loan refers to a mortgage loan that conforms to the rules and standards of a GSE such as Federal Home Loan Banks (FHLB), Fannie Mae, Freddie Mac, or Farmer Mac. A GSE loan is not generated by a GSE but by a private lender who agrees to conform to GSE rules.
“When deciding whether to choose a government-sponsored enterprise loan or a conventional loan, there are many factors to consider from the perspective of the consumer,” says LBC Mortgage founder and CEO, Alex Shekhtman.
“One key difference between the two types of loans is that GSEs may be more willing to lend to borrowers with weaker credit, whereas conventional lenders typically require a higher credit score,” Shekhtman says. “This may make GSE loans a better option for those who do not have perfect credit.”
If you obtain a Fannie Mae, Freddie Mac, or conventional mortgage loan from a lender who agrees to adhere to conforming loan rules, it will be considered a conforming loan with a maximum loan limit, required minimum down payment, minimum credit score, minimum debt to income (DTI) ratio, and a specified interest rate. If your down payment is less than 20% of the purchase price, private mortgage insurance (PMI) will be required, which you must pay monthly until you have at least 20% equity in your home.
Loans that do not follow these rules are considered nonconforming. One example of a nonconforming loan is a jumbo loan or mortgage loan on a property that costs more than the maximum loan amount for a conforming loan.
Examples of GSEs
The main GSEs that lenders deal with are the Federal Home Loan Banks, Farmer Mac, Fannie Mae, and Freddie Mac.
Federal Home Loan Banks
One of the earliest GSEs, the FHLB system was established by the government in 1932. It is made up of 11 regionally based, wholesale suppliers of funds to member financial institutions including community banks, credit unions, commercial and savings banks, insurance companies, and community development organizations. FHLBs are cooperatively owned by member financial institutions in all 50 states and US territories.
Established In 1988, Farmer Mac helps stabilize the agricultural lending market by guaranteeing repayment of principal and interest to agricultural bond investors. Farmer Mac functions as a secondary market by purchasing agricultural loans, guaranteeing bonds, providing credit protection, and providing wholesale financing to lenders.
Fannie Mae was founded in 1938. It purchases mortgages from large commercial financial institutions. This returns funds to the bank, which lends to another borrower. Fannie Mae sells the mortgage and recovers its initial investment. The cycle keeps the lending economy moving.
Freddie Mac was founded in 1970. The main difference between Fannie Mae and Freddie Mac is that Freddie Mac buys mortgages from smaller banks and lenders instead of commercial banks. Otherwise, their functions are essentially the same.
GSE mortgage requirements
In addition to the loan type requirements listed above, there are individual qualification requirements to obtain a mortgage loan. For example, both a GSE and a conventional loan typically require a minimum credit score of 620, while a nonconforming jumbo loan typically has a higher credit score requirement (680 to 760).
Another factor is debt-to-income ratio. For a GSE loan, you can spend as much as 50% of your monthly income on debt. For both conventional and jumbo loans, debt payments must be 45% or less of your monthly income.
Although GSE loans make homeownership more accessible to low- and moderate-income buyers, Shekhtman says there are times when a GSE loan may not be the best option.
“Borrowers who have good credit but who are seeking a low down payment loan may be better off with an FHA loan,” he says. “Additionally, those who are planning to sell their home within a few years may not benefit from the added stability of a GSE mortgage.”
The bottom line
As a homebuyer, you will never interact with a GSE, even though there’s a better than 50% chance your loan will fall under GSE guidelines.
Keep in mind that GSE minimums are not a goal, but a benchmark. Strive to have a credit score above the minimum, a DTI less than 50%, and the ability to make the largest down payment you can. The reasons are simple: The higher your credit score and down payment and the lower your DTI, the lower your interest rate and payment will be.