To automate any process, one first must establish precise parameters for the finished product. As that applies to circuit boards, appliances or mass-produced snacks, so it applies to home loans. In the 21st century U.S. mortgage market, most home loans spring from capital markets where mortgages are funded by investors.

By and large, the conforming mortgage borrowers that scale Fannie Mae and Freddie Mac’s underwriting ladder are the cream of the prospective homebuying crop: middle- to upper-income, well-reserved, stably employed and not over-indebted. The guidelines that render a mortgage eligible for purchase by either of those government-sponsored entities (GSEs) function to homogenize the loans they purchase and the borrowers they serve.

A conforming mortgage and conforming mortgage borrower are not the finished product, but the predictable payment schedule of thousands bundled together. In fact, conforming mortgage performance is so predictable that even the most conservative institutional investors buy shares of those interest-bearing securities.

Capital markets’ demand for “agency” mortgage-backed securities (MBS) runs so deep that the GSEs can purchase whole loans and pools of mortgages not knowing who the final buyers will be, just that they will buy. That “to be announced” (TBA) market is the flywheel turning investor capital into funded conforming loans.

Welcome to the 21st century, Fannie Mae and Freddie Mac — your conforming supply chain is hollowing out.

Legacy mortgage liquidity

“The people that are thinking, ‘Oh, I’m just going to deliver Fannie and Freddie loans for the next 20 years and I’m going to be OK,” warns Seth Sprague, director of mortgage banking for Richey May, a tax audit and advisory firm, “if they haven’t figured it out yet, they’ll realize that that’s not enough liquidity for them anymore.”

On a macroeconomic level, a middle class that has been shrinking since the 1970s now confronts substantially higher costs of living in 2025 than before the 2008 financial crisis that lodged Fannie and Freddie, the country’s largest mortgage investors, in government conservatorship. Now, the labor markets supporting a middle- and upper-income bracket of conforming mortgage borrowers are experiencing rapid disruption by artificial intelligence and overhauls to U.S. trade and immigration policies.

“That population will continue to shrink on both sides,” says Sprague, driven to government loans, better pricing on enhanced loan delivery on banks’ balance sheets or in nonagency, private securitization markets. “How many people can actually afford a mortgage? I think that number is not going up.”

In 34.3% of U.S. counties analyzed in the third quarter by the real estate market analytics firm Attom, home expenses on a median-priced home exceeded 43% of typical wages, a benchmark considered seriously unaffordable. Trump administration actions to shrink the federal government and reduce spending mean household budgets for millions of marginal mortgage borrowers will soon have to contend with widespread reductions in government assistance.

Consumer spending drives the U.S. economy but increasingly depends on spending by high-income households. The ratings agency Moody’s Analytics assessed that the top 10% of earners accounted for nearly 50% of total consumer spending in the second quarter, on par with the first quarter.

“You think about the age demographics,” Sprague continues, “there’s still that slug of pretty decent 31- to 38-year-olds that are trying to creep up to that housing piece, but if you look over the hill, that next generation is a lot smaller. What’s going to happen with housing inventories?”

With total mortgage production volumes so low, all but the largest mortgage lenders and servicers struggle to originate enough loans to distribute fixed costs. Anything that weakens the U.S. consumer — and more specifically, potentially hollows out the middle class — does not brighten the horizon for any owner-occupied mortgage activity, much less conforming volumes.

The crux of the challenge facing legacy mortgage liquidity providers Fannie Mae and Freddie Mac is that as GSE market share shrinks, capital markets for nonagency mortgages have blossomed after the financial crisis’ veritable clear-cut of private mortgage lending. In a generational housing shift driven by affordability barriers, a shrinking supply chain means agency MBS investors may shrink their stake in the finished product.

Institutional meets nonagency

The uptake of non-qualified mortgages (non-QM) and loans for residential real estate investors has accelerated in recent years due in large measure to enhanced capital markets execution — better loan delivery on better-performing loans to whole loan or private-label MBS investors through standardized securitization technology.

From home equity lending to non-QM to single-family rentals, technology that has dramatically reduced the time and cost of information verification and loan funding has enhanced the predictability of returns for end investors and enhanced transparency for rating agencies ultimately gauging the riskiness of the underlying collateral.

“The difference between a rated bond and unrated bond is pretty significant in terms of the types of investors that can ultimately buy the bonds, and the liquidity you have for those bonds,” says John Beacham, founder and CEO of Toorak Capital Partners, a lender to real estate investors. “That all translates into a lower cost of capital, so you could sell the same bond at a lower interest rate than you can if it’s unrated.”

Beacham pioneered the raising of capital markets for loans to residential real estate investors, asset classes functionally capped by a lack of institutional backing. By standardizing a process to spit out the product he sought, not unlike the GSEs, Beacham brought the first single-family rental (SFR) securitization to market in 2013, the first multi-borrower SFR securitization in 2015, and eventually the first residential transition loan (RTL) securitization in 2024.

“The idea was,” he explains, “let’s go create a standardized product for the RTL market, partner with high-quality lenders around the country, and then institutionalize it through standardization and rigorous credit standards.” Only one agency, Morningstar DBRS, has rated RTL pools, but Beacham expects demand to rise on the market’s shifting tide.

With roughly one-third of home sales going to an investor buyer in the second quarter of 2025, lenders will ignore that buyer segment at their own peril. Mortgage rates are forecast to stay at or above 6% through the end of 2026. High home prices, though softening, remain propped up by chronic undersupply. Total home sales through August 2025 hover at an annualized sales pace of 4 million units, right around 2024’s three-decade lows.

With lock-in effects well anchored and builders pausing new projects as their standing inventory swells, the need to meet housing demand continues to transform the capital markets that support originations. In an era of elevated volatility and sustained low production, maturing nonagency markets also offer investors more reward for purportedly comparable risk. But more issuance is needed for stronger ratings, Beacham adds.

“You’d also expect to move from a single-A cap to AAA over time, like every other asset class, as there’s more experience, more maturity and the market develops,” he says. “All these things I think over time are going to lead to more investor interest in our space.”

According to Optimal Blue, a mortgage capital markets platform, nonconforming loan share hit 17.3% of all originations in August. Conforming loan share was 51% and government loans backed by the Federal Housing Administration, Department of Veterans Affairs and U.S. Department of Agriculture totaled 31.8%.

Shrinking conforming share

Justin Grant, senior director and head of investor services at Mortgage Capital Trading, a capital markets advisory for mortgage lenders, has watched agency market share fall from 60% to around 40% over the past several years. If the long end of the yield curve steepens, demand for 30-year conforming mortgages that are the foundation of U.S. housing finance markets may recede further due to affordability and shifting demographics.

“I think that’s already been happening,” he says, calling it a “direct result” of private lending’s maturation. “Portfolio loan products, nonagency and non-QM in particular, as a direct result offering some more flexibility outside of what the agencies require. We’ve already seen trends in that direction.”

The growth of nonagency market share faces structural limitations in the origination market, though. The buyers of non-QM loans who Grant speaks with are excited about demand but frustrated about slow uptake, given swelling demand from secondary investors to buy the mortgages.

“A lot of the lenders out there have been so used to agency production, and this is such a different type of product for them, that there’s a lot of training required for the lender but also their loan officers,” Grant says. The narrowing of GSE market share and shrinking pool of agency-eligible borrowers can hasten that pivot, though.

Pending the Trump administration’s success in achieving its stated goal of taking Fannie and Freddie public but preserving their implicit guarantee on credit risk, the conforming mortgage market faces pressure from all sides. Industry analysts worry that failing to translate the implicit government guarantee into the GSEs’ post-conservatorship structure could send mortgage rates soaring. Privatization or shrinking the GSEs’ footprint could have a similar effect.

“If they shrink the agencies’ footprint even more, that’s probably more of a tailwind for the nonagency space,” Grant explains. “As a result of all that too, you’re seeing a lot more investors come into the space that want to buy and have exposure to nonagency products, the traditional agency-only lenders, a lot of the big names.”

Nonagency products like non-QM and investor loans have wider margins and thus are more profitable for lenders. For the small and midsize mortgage lenders doing enough to get by, will it work to just keep selling to Fannie and Freddie?

“It’s a good question and it’s probably timely, too,” says Grant. An economic downturn would test the resolve of institutional investors’ renewed appetite for private-label mortgages. Historically, they’ve fled, he says.

“If we were to see some sort of market shock, I expect that with a recession you’d see a flight back to those agency-eligible, Fannie-, Freddie-, Ginnie [Mae]-backed loans,” Grant hedges, “that their share would increase.”