Freddie Mac

A federally-backed government-sponsored enterprise

What is Freddie Mac?

Freddie Mac is the unofficial title for the Federal Home Loan Mortgage Corporation, a federally-backed government-sponsored enterprise created in 1970 to broaden the secondary mortgage market and deflate interest rate risk for banks.

 

Freddie Mac

 

According to its charter, Freddie Mac “establishes secondary market facilities for residential mortgages [and] provides that the operations thereof shall be financed by private capital to the maximum extent feasible.” In essence, Freddie Mac’s mission is to provide liquidity, stability, and affordability in the housing market.

 

How It Works

Here’s a brief, step-by-step breakdown of how Freddie Mac enables a more liquid, stable, and affordable housing market.

Step 1: Freddie Mac purchases mortgages from banks and/or other lenders.

Step 2: Similar mortgages are bundled together to create a type of asset-backed security.

Step 3: Shares of the security 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 simple terms, the government does not truly purchase any mortgages but instead buys mortgages issued through lenders in the secondary mortgage market and bundles them into mortgage-backed securities sold to investors.

 

Understanding the Purpose of Freddie Mac

Freddie Mac leverages the use of an asset-backed security called mortgage-backed securities to achieve a few primary goals:

  1. Expand the secondary mortgage market and enable more available loans. As reported by The New York Times in May 2020, nearly 70% of all home loans are federally backed in the U.S. today.
  2. Consequently, there is an increased capacity of banks to give out loans, and interest rates remain low, which provides consistency across the country. A report from September 2020 found that mortgage rates among states within the U.S. differed only by 0.2%.
  3. By providing investors and insurers with the opportunity to participate in the mortgage market, Freddie Mac spreads credit risk among many investors, reducing the burden on America’s taxpayers.

 

In fact, Freddie Mac finances approximately one out of every four U.S. home mortgages. Although Freddie Mac and mortgage-backed securities widened the horizon of the housing market, they led to an asset bubble that burst in 2006, making way for the 2008 Global Financial Crisis.

Nonetheless, Freddie Mac’s role as part of the Emergency Home Finance Act (1970) created a real estate boom. It continues to stimulate the housing market, prevents foreclosures for several homeowners, and protects mortgage rates from external fluctuations.

 

Freddie Mac’s Business Lines

Freddie Mac oversees three primary business lines:

  • Single-family: Offers mortgage-backed funding for single-family homes
  • Multifamily: Supports renters and apartment owners through mortgage-backed housing loans
  • Capital markets: Supports the liquidity of the housing market by purchasing mortgage-backed securities in Freddie Mac’s investment portfolio

 

Freddie Mac vs. Fannie Mae

As part of the Emergency Home Finance Act (1970), Freddie Mac was created as a rival competitor to Fannie Mae – Federal National Mortgage Association. Also known as Freddie’s “big brother,” Fannie Mae differs from Freddie Mac in a pivotal way.

Freddie Mac prioritizes purchasing mortgages from smaller-sized banks focused on providing financial loans and services to communities. In contrast, Fannie Mae purchases mortgages from major retail/commercial banks and requires the loans to be approved by the Federal Housing Association.

 

Similarities

  • Freddie Mac and Fannie Mae paved the way for more affordable housing in America.
  • Both are government-sponsored entities held within a conservatorship of the Federal Housing Finance Agency.
  • Both compete as investor rivals in the mortgage market and enable liquidity to mortgage lenders.
  • Freddie Mac and Fannie Mae were both created with public housing missions – targeting the lack of affordable housing and the expansion of the secondary mortgage market.

 

Differences

  • Fannie Mae buys mortgages from commercial banks like JPMorgan Chase, while Freddie Mac buys them from much smaller banks.
  • Both adopt different approaches to mortgage approval and the assessment of a potential borrower’s financial profile, which includes their credit history, debt levels, and current income.
  • Fannie Mae and Freddie Mac differ in lending requirements and programs. Both offer different guidelines about low/minimum down payments. Fannie Mae offers the HomeReady loan, in which applicants cannot make more than 80% of the area’s median income. Freddie Mac’s twin offering – Home Possible loan – requires that applicants cannot make more than the area’s average income.

 

Freddie Mac in the COVID-19 Pandemic

During the COVID-19 pandemic in 2020, several banks and financial institutions rolled out mortgage deferral and other assistance programs to allow homeowners financial flexibility due to the ill effects of the pandemic.

To counter its effects from seeping into the Freddie Mac mechanism, the government created the Coronavirus Aid, Relief, and Economic Security (CARES) Act. The CARES Act protects homeowners against foreclosures and provides mortgage relief as long as they hold associated mortgages with Fannie Mae and Freddie Mac.

 

Additional Resources

CFI is the official provider of the Commercial Banking & Credit Analyst (CBCA)™ certification program, designed to transform anyone into a world-class financial analyst.

To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

  • 2008 Global Financial Crisis
  • Amortizing Loan
  • Foreclosure
  • Home Mortgage