What is an Agency Loan? Pros and Cons

Real estate investors can obtain finance for purchasing a multifamily property either through conventional bank loans or agency loans. Multifamily properties are residential buildings having five or more units. Agency loans have been existence in USA for decades but not many real estate investors have even heard about it. Here we will discuss the various features including merits and demerits of agency loans.

Meaning of Agency Loan

Agency loans are federally-backed low risk loans provided by government-sponsored enterprises or GSEs. The two main GSEs providing agency loans are Federal National Mortgage Association or Fannie Mae and Federal Home Loan Mortgage Corporation or Freddie Mac.

The GSEs themselves do not originate or service the agency loans. Agency loans are provided by private lenders to the borrowers which are then purchased by Fannie Mae or Freddie Mac. Fanny Mae or Freddie Mac combine the agency loans with other loans as mortgage-backed securities and sells them to the investors in the secondary mortgage market. Freddie Mac buys loans mainly from small banks while Fanny Mae buys mortgage loans from commercial banks.

The GSEs such as Fanny Mae and Freddie Mac underwrite agency loans on the basis of the value of the underlying asset which is the multifamily property owned by the borrower. The agency gets the property appraised by a third party to determine its value and detect maintenance issues. Maintenance issues need to be rectified before approval of the loan. In addition, the agency also makes an assessment of the net worth, liquidity and even the real estate experience of the borrower. The renters living in the property are also assessed.

Agency loans provided by multifamily lending agencies have a lower limit of USD 1 million. This is because appraisal and other administrative costs associated with agency loans which are borne by the borrower make them unsuitable for loan amounts below USD 1 million.

Agency loans provide up to 75-80% LTV of the property. LTV is the ratio of the loan value to the property value.

Eligibility for Agency Loan

Agency loans are provided on two types of leased income-generating properties, namely multifamily properties and manufactured housing communities. Property occupied by the owner itself is not eligible for agency loans. Construction projects and properties where health services are provided also do not qualify for agency loans.

The net worth of the borrower should be greater than or equal to the loan amount. As regards the liquidity of the borrower, it should be greater than equal to 9 months payment of principal and interest.

An individual owner of the property must have a credit score of 680 or more to be eligible for an agency loan on the said property. However, if there are multiple owners of the property, then the minimum required credit score can be 620.

With respect to experience, the requirements of Fannie Mae and Freddie Mac differ. Fannie Mae requires the borrower to have an experience of a minimum of 2 years in managing at least one multifamily property of a similar size. Freddie Mac, on the other hand, requires the borrower to have the ownership of at least 3 multifamily properties with ownership of a minimum of one multifamily property for preceding 2 years.

Freddie Mac and Fannie Mae differ in some other requirements as well. Thus, it is possible to be eligible for agency loan from one kind of agency and not from the other.

Aspect	Pros	Cons
Interest Rates	Often lower interest rates due to government backing	Can be slightly higher for borrowers with less-than-perfect credit
Down Payment	Lower down payment requirements, often as low as 3%	Might require mortgage insurance for down payments less than 20%
Credit Requirements	More lenient credit requirements compared to conventional loans	Minimum credit scores still required, may not be accessible for those with very poor credit
Loan Limits	High loan limits, especially in high-cost areas	Borrowers needing loans above these limits must consider non-agency options
Availability	Widely available through numerous lenders	Availability may be subject to stricter eligibility criteria in certain circumstances
Refinancing	Easier to refinance, with streamlined processes for certain loan types	Refinancing fees and closing costs can still apply
Repayment Terms	Flexible repayment terms, including fixed and adjustable-rate options	Long-term commitments can be daunting, and adjustable rates may increase over time
Subsidies and Programs	Eligibility for special programs like FHA, VA, and USDA loans, which offer additional benefits	Not all borrowers qualify for these programs, and they often have specific usage restrictions
Government Backing	Increased security and reduced risk for lenders, which can translate to better loan terms	Government backing doesn’t eliminate the risk of foreclosure for borrowers
Processing Time	Standardized processes can lead to faster approvals in some cases	Still subject to thorough underwriting, which can be time-consuming in certain situations
Fees and Costs	May have lower fees and closing costs compared to non-agency loans	Additional fees may still be required, such as funding fees for VA loans
Market Stability	Generally more stable and less susceptible to market fluctuations due to government involvement	Less flexibility in negotiation due to standardization

Pros of Agency Loan

Agency loans allow unrestricted cash out on refinances which enable the borrowers to leverage higher equity for cash as compared to other loans. Thus, if the loan amount sanctioned under agency loan exceeds the existing loan balance on the property, then the excess funds can be used for anything without restrictions.

Agency loans are non-recourse in nature. Non-recourse means the borrowers are not personally liable to repay the loan in the event of default or foreclosure and the lender is not able to recover the loan balance by selling the property or the loan. However, legal remedies are available for the lenders in case of fraud or misrepresentation.

Interest rates of agency loans are much lower as compared to other types of loans. This is possible because the lenders do not have much risk since the loans are backed by the GSEs. GSEs, in turn, are able to offer lower interest rates by securitizing and selling the loans as mortgage-backed securities to the investor market. The interest rates can be fixed or floating over the loan period depending upon the option chosen by the borrowers.

Freddie Mac and Fannie Mae provide fixed-rate interest rates agency loans for a period of 5-10 years. The repayment period can be increased to 20 years by changing the interest rate at the end of the fixed-rate period. Floating rate agency loans are also offered for 5-30 years. Loan amortization for 25-30 years with only interest payments in the initial few years is also possible with agency loans.

Agency loans provide access to much more capital as compared to other types of loans. Minimum amount which can be approved by agency loans is USD 1 million while the maximum limit is USD 100 million.

Agency loans are assumable. This means if the borrower sells the property before the end of the loan period, the buyer assumes the loan.

Cons of Agency Loan

Agency loans are difficult to qualify for and usually come with restrictions relating to the usage of the property. The minimum requirement of USD 1 million to qualify for agency loans is also a disadvantage.

Agency loans can place restrictions on prepayment with high prepayment penalties. However, the agency can impose a reducing step-down prepayment penalty in lieu of higher interest rate.

There are substantial costs associated in applying for agency loans. These include lender’s legal charges, fees for the property appraisal and condition report, survey charges and title insurance costs.

Conclusion

Fannie Mae and Frederick Mac backed agency loans are widely preferred by investors of multifamily properties primarily because the risk of default is much lower as compared to non-agency loans. The borrowers are required to choose between Freddie and Fannie as per their specific financial needs.