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While most American adults may have heard the names Freddie Mac and Fannie Mae in the news or print media, they may have little to no idea what these two mortgage giants represent.
However, for homeowners or intending homeowners, Freddie Mac and Fannie Mae represent a whole dimension of mortgagepossibilities.
And if you are in the market for your next mortgage, knowing more about Freddie Mac or the Federal Home Loan Mortgage Corp can influence your entire home buying experience.
This article will highlight some critical aspects about Freddie Mac and what this government-sponsored entity represents.
Let’s get started!
What is Freddie Mac?
To clear up some misconceptions, Freddie Mac is not an actual person. But it is a widely acceptable representation of the company’s full name, the Federal Home Loan Mortgage Corporation or FHLMC.
Freddie Mac, just like Fannie Mae, is one of the two big players in the U.S. secondary mortgage market.
Chartered as a government-sponsored enterprise (GSE) by the U.S. Congress in 1970, Freddie Mac is charged with buying, guaranteeing, and securitizing mortgages from mortgage lenders or small banks, which in turn provide lenders with more money to finance home purchases.
Over the years, Freddie Mac, combined with Fannie Mae, has made it possible for over 66% of Americans to achieve their homeownership dream ─ the true American Dream.
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How Does Freddie Mac Work?
If you’re like millions of potential home buyers, you may be wondering how Freddie Mac works and the role they play in the whole mortgage scheme of things.
While the sole aim of Freddie Mac is to purchase mortgages from smaller banks and online mortgage lenders, there is, however, a standard way it works to enable a more liquid, stable, and affordable housing market across the country.
- Step 1: Freddie Mac purchases mortgages from banks and other mortgage lenders.
- Step 2: Similar mortgages are bundled together to create a type of asset-backed security.
- Step 3: Security shares are then sold to pension funds, insurance companies, and individual investors, which grants them the right to the value of bundled mortgages.
- Step 4: Freddie Mac guarantees a consistent pay-out to the shareholders per month.
- Step 5: When the borrower makes monthly mortgage payments, the bank forwards the payments to Freddie Mac.
- Step 6: Freddie Mac combines payments from the different mortgages, charges a fee, and forwards the rest to the respective shareholders.
In a nutshell, Freddie Mac doesn’t originate or make home loans available directly to the final homebuyer.
Instead, Freddie Mac buys bundled mortgages from banks and private lenders who issue home loans to home buyers. By selling mortgages to Freddie Mac as mortgage-backed securities.
For example, let’s say AYB bank has $10 million to invest in local mortgages. If the typical mortgage amount is $400,000, then the bank can originate 25 home loans.
That is, ($400,000 x 25 = $10 million.) So, if you happen to be borrower number 51 in this situation, there’s no lending money left for you. That’s where the Freddie Mac comes in.
AYB bank takes its 25 mortgages and sells them on the secondary market to Freddie Mac to solve this issue. The bank now has new cash and can continue making local mortgages.
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Brief History of Freddie Mac
The U.S. Congress created Freddie Mac under the Emergency Home Finance Act of 1970. Upon creation, it was capitalized with a contribution of $100 million to enable the purchase of long-term home loans.
And as a subsidiary of the Federal Home Loan Bank System (FHLBS), Freddie Mac was more focused on reducing interest rate risk for loan associations and smaller banks.
In 1989, the U.S. Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) which saw the structure of Freddie Mac reorganized to become a for-profit corporation owned by private shareholders. With this, shares of Freddie Mac could be publicly traded on the New York Stock Exchange.
During the 2008 financial crisis, due to the subprime mortgage crisis, which led to the Great Depression, Freddie Mac ran into a significant loss, making it unable to guarantee all its risky loans.
To save Freddie Mac from further loss, Congress authorized the treasury department to purchase up to $200 billion in its preferred stocks to save the mortgage industry.
Since 2008, Freddie Mac has been under the Federal Housing and Finance Agency (FHFA).
While Freddie Mac is gradually moving toward independence, it is still under the conservatorship of the FHFA.
What Does Freddie Mac Do?
It is no longer news that Freddie Mac is a significant player within the U.S mortgage industry and the larger economy.
According to a report by Fortune, Freddie Mac is ranked 40th in the list of top U.S. corporations in terms of revenue.
Generally, Freddie Mac does the following:
- Provide liquidity to the nation’s mortgage finance system
- Freddie purchases home loans made by private firms (provided the loans meet strict size, credit, and underwriting standards)
- Package those loans into mortgage-backed securities
- Guarantee the timely payment of principal and interest on those securities to outside investors
- And above all, Freddie Mac also holds some home loans and mortgage securities in their investment portfolios
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How Does Freddie Mac Affect the Mortgage Market?
One significant fact we all can agree to is that Freddie Mac makes homeownership a possibility for every potential home buyer.
Without the role of Freddie Mac in the U.S. mortgage market, the majority of loan associations, banks, and private lenders may have to hold mortgages in-house.
Like in our above example, banks will be faced with tied-up capital, and homebuyers will have to deal with exorbitant interest rates to help lenders make a profit.
In a nutshell, the presence of Freddie Mac in the U.S mortgage market has made home loans easily available to potential homebuyers and at a lower interest rate.
What Does FHLMC Stand For?
FHLMC stands for Federal Home Loan Mortgage Corporation. But popularly referred to as Freddie Mac, one of the two government-sponsored enterprises.
Differences Between Freddie Mac and Fannie Mae
While Freddie Mac and Fannie Mae are both government-sponsored enterprises, there are specific differences between them. Below are some of the differences:
- Fannie Mae buys mortgages from institution-like banks like JPMorgan Chase while Freddie Mac buys home loans from smaller local banks
- Both have a different approach to mortgage approval and evaluation of a potential borrower’s financial information
- Both have different lending requirements, guidelines, and down payment. A few good examples are Fannie Mae HomePath, Fannie Mae’s HomeReady loan, and Freddie Mac Home Possible loan.
>> More: Freddie Mac vs. Fannie Mae
Bottom Line: What is Freddie Mac?
Over the years, Freddie Mac and its sisters Fannie Mae and Ginnie Mae have played a pivotal role in mortgage affordability by purchasing home loans from banks on the secondary market.
Without the involvement of Freddie Mac, millions of existing and potential homeowners will have to deal with high-interest rates and origination fees.
More importantly, Freddie Mac offers stability and transparency in mortgage lending processes.