A Conventional Home Loan, technically, is any home loan that is not guaranteed by the US Government, such as a VA Home Loan, FHA Home Loan, or USDA Home Loan.
More often than not though, a Conventional Home Loan is referred to as a Conforming Home Loan, which is home loans that conform to the guidelines set forth by Freddie Mac and Fannie Mae, which are the two government-sponsored enterprises (GSEs) that provide liquidity for the Conforming Home Loan mortgage market.
Conventional Home Loans can include mortgages include portfolio loans, construction loans, and even subprime loans. But again, most of the time when you think of a Conventional Home Loans or lenders refer to them, they are most likely referring to conforming mortgages that are eligible for purchase by Fannie Mae and Freddie Mac.
Who Is Fannie Mae and Freddie Mac?
These two publicly traded companies and Government Sponsored Enterprises (GSEs) are the largest mortgage-backed security source in the United States today.
In the beginning, Fannie Mae was originally introduced as part of President Roosevelt’s New Deal but was later privatized in 1968.
Freddie Mac is 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 liquidity to continue writing home loans for real estate.
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. However, if the bank tied up their money for 30 years, they'd eventually run out of cash to lend on other real estate, auto loans, credit cards...
Fannie Mae and Freddie Mac 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.
It is important to understand that neither Freddie Mac nor Fannie Mae service (the collection of payments on a home loan, otherwise known as the servicer) the loans they purchase.
Basically, even though these companies purchase loans from various lenders, it is the lender who retains the servicing – just a fancy way of saying "we collect your payments."