Freddie Mac Guidelines: Seller-Owned Converted Mortgages

What Are Seller-Owned Converted Mortgages

A seller-owned converted mortgage starts as an adjustable-rate mortgage that the original lender later converts to a fixed rate. The lender then sells this converted loan to Fannie Mae as a seasoned mortgage.

This happens when borrowers want to lock in their rate after their ARM has been on the books for a while. Maybe rates dropped since they got their original loan, or they want payment stability. The lender converts the ARM to a fixed rate using terms that were built into the original loan documents.

Say you got a 5/1 ARM three years ago when rates were higher. Now rates have come down and you want to convert to a fixed rate using the conversion option in your original mortgage. Your lender processes the conversion, then sells your newly fixed-rate loan to Fannie Mae under these special guidelines.

Loans That Cannot Be Converted

Fannie Mae excludes several specific loan types from this conversion process. Community Land Trust mortgages cannot be converted and sold this way. These loans involve properties where a nonprofit organization owns the land and sells only the home to keep housing affordable.

HeritageOne mortgages also cannot be converted. These are specialized loan products with unique terms that Fannie Mae handles differently in their system.

Properties with income-based resale restrictions present another exclusion. These restrictions typically limit how much you can sell the property for based on area median income levels. The key factor is whether these restrictions terminate when the property goes into foreclosure.

If the restrictions end at foreclosure or when a deed-in-lieu gets recorded, the loan cannot be converted and sold to Fannie Mae. The lender must determine property value using special appraisal methods outlined in Section 4406.4(c) for these properties.

Buydown Complications

Temporary subsidy buydown plans create a complete barrier to conversion. These plans involve funds set aside at closing to reduce your monthly payments for the first few years of the loan.

If your original ARM included a temporary buydown, the lender cannot convert it to a fixed rate and sell it to Fannie Mae. Any money left in the buydown account must be distributed according to the original buydown agreement when the conversion happens.

This means if you had a 2-1 buydown on your original ARM and want to convert after 18 months, the remaining six months of buydown funds get handled per your original paperwork. The lender cannot just roll these funds into the converted loan.

Conversion Requirements the Lender Must Meet

The original lender must verify that all conversion terms in the original note and security instrument have been satisfied. These terms were written into your loan documents when you first got the ARM.

Common conversion requirements include waiting periods, rate adjustment dates, and borrower notification procedures. Your lender must document that they followed every step outlined in your original mortgage paperwork.

The converted note must be negotiable, meaning it can be legally transferred and enforced. The entire debt must remain fully enforceable against you as the borrower. The mortgage must maintain its first lien position on the property.

Fixed-Rate Structure After Conversion

Once converted, the mortgage must have a fixed interest rate with level monthly principal and interest payments. This means your payment amount stays the same each month for the remaining loan term.

The lender cannot create a converted loan with graduated payments, interest-only periods, or balloon payments. Fannie Mae requires the standard fixed-rate amortization schedule.

A due-on-sale clause must remain in effect after conversion. This clause allows the lender to demand full payment if you sell or transfer the property. Fannie Mae requires language similar to what appears in their current uniform mortgage instruments.

Documentation the Lender Must Provide

The lender must warrant in writing that all original conversion terms were met. This warranty protects Fannie Mae if problems arise later with the conversion process.

Documentation typically includes the original note and security instrument showing the conversion provisions. The lender provides evidence that waiting periods were observed and proper notices were given to the borrower.

The converted note itself must meet Fannie Mae's negotiability standards. This includes proper endorsements and assignments that create a clear chain of title for the mortgage.

Why These Rules Exist

Fannie Mae created these restrictions to manage risk in the secondary mortgage market. Converted mortgages have different risk profiles than loans originated as fixed-rate products from the start.

The exclusions for Community Land Trust and HeritageOne mortgages reflect their specialized nature and different servicing requirements. These loans need customized handling that doesn't fit the standard converted mortgage process.

Properties with income-based resale restrictions create valuation challenges. If these restrictions disappear at foreclosure, the property's recovery value becomes uncertain. Fannie Mae prefers to handle these loans through other channels.

The buydown exclusion prevents complications with subsidy fund management. Converting a loan with active buydown funds creates accounting and servicing complexities that Fannie Mae wants to avoid.

Common Problems That Arise

Lenders sometimes miss conversion deadline requirements in the original loan documents. If the borrower waited too long to request conversion, the option may have expired. The lender cannot ignore these deadlines just to make a sale to Fannie Mae.

Documentation gaps create delivery problems. If the original note is missing key conversion language or the lender cannot prove they followed proper procedures, Fannie Mae may reject the loan.

Property restriction issues surface during the delivery process. Lenders may not realize a property has income-based resale restrictions until they prepare the loan for sale. Title work and property records must be carefully reviewed.

Interest rate calculation errors happen when lenders convert ARMs to fixed rates. The conversion rate must be calculated exactly as specified in the original loan documents. Lenders cannot negotiate new rates or terms during conversion.

References

For the official guidelines, see 4402.2: Special requirements for Seller-Owned Converted Mortgages in the Fannie Mae Selling Guide.