Freddie Mac: Everything you need to know about FHLMC
Most American adults have probably heard the names Freddie Mac and Fannie Mae at one point or another, but they’re not necessarily sure who they are or what they are. There’s a down-home quality to the names that evokes a certain colloquial charm, something that belies the purposeful function of these housing market titans.
What does Freddie Mac do?
Both Freddie Mac and Fannie Mae are hugely influential government-sponsored enterprises whose primary purpose is to spur liquidity and maintain stability and affordability within the nation’s housing supply. They do this by purchasing loans from mortgage companies and banks, packaging them together with other similar loans and then selling them as securities. By selling these securities at competitive rates on the secondary market, Freddie and Fannie are able to increase the flow of available funds and help reduce interest rates for borrowers.
While both entities play an important role in today’s housing market, in this article we’re going to dive deep into Freddie Mac; its history, its core function and how it provides value to millions of homeowners across the country—many of them only vaguely aware of Freddie’s true influence.
History and purpose of Freddie Mac (FHLMC)
The Federal Housing Loan Mortgage Corporation (FHLMC), or simply Freddie Mac, was chartered by the federal government in 1970 to provide an ongoing flow of capital to mortgage lenders to support the housing market and increase affordable American homeownership. Prior to Freddie Mac (and Fannie Mae), there was precious little regulation and even less specific stimuli working to maintain liquidity and stability within the retail housing sector.
In the beginning, there was Fannie Mae
Fannie Mae (Federal National Mortgage Association) was set up by the government in 1938 during the Great Depression as part of the New Deal to help foster a more reliable flow of mortgage-related funds in order to support an increase in affordable housing. Freddie Mac, conceived with a similar mission, was not established by Congress until some 30 years later.
The inception of Fannie Mae laid the groundwork for the great post-World War II housing boom and helped provide middle class families secure, affordable financing. This was made possible not just by the infusion of federally backed loans, but by creating a “secondary market” for these loans whereby they could be packaged together and sold as securities. These are called mortgage-back securities (MBS).
The secondary market-—really a bond market—made the entire business model profitable and created a viable path for banks and other lenders to confidently issue fixed-rate 20- and 30-year loans. For consumers, the benefit was clear: Retail mortgages could now be paid back slowly and predictably, providing local economic stability. On the lending side, the ability to package and sell home loans as a security provided a means to replenish liquidity and spur lenders to actively fund new loans.
Privatization and the birth of Ginnie Mae and Freddie Mac
In the ensuing years, Fannie Mae continued to stabilize the market and create a growing, satisfied chain of lenders and homeowners. However, in the late 1960s, a couple things happened in relatively quick succession that reshuffled the original concept. First, due to certain fiscal priorities, the government removed Fannie from the federal budget in 1968 and converted it to a privately held corporation responsible to its shareholders. It had already been made a “mixed-use company” by an act of Congress in 1954 and now it would be fully privatized.
In doing so, they also created a specific mortgage entity for backing and buying government-backed loans such as FHA, VA or USDA loans. The Government National Mortgage Association, or Ginnie Mae. These loans are 100% insured by the federal government.
Then in 1970, Congress decided Fannie needed some in-market competition so they came up with the FHLMC—Freddie Mac. Similar in scope and purpose, there have always existed some crucial differences between these two entities. While Fannie Mae focused on buying up mortgages from the largest banks in the land, Freddie Mac was enlisted to purchase retail mortgages from many of the smaller community banks—sometimes called “thrift banks”— and savings & loans.
They also offer different programs and have different loan eligibility guidelines. The consensus view from both government and financial experts was that broader, more complete lending coverage was healthy for the consumer, the mortgage financing system and the larger economy, of which Freddie was now playing a key role.
Both Fannie Mae and Freddie Mac are known as government-sponsored enterprises (GSEs). This means that while they are private corporations with a fiduciary responsibility to individual shareholders, they have been chartered by Congress with a government objective to promote affordable homeownership by purchasing conventional mortgages from banks and other lenders that fit their respective guidelines. In short, GSEs have both a public and private responsibility.
While the loans they purchase are not technically backed by the full faith and credit of the U.S. government, there exists an implicit guarantee that the U.S. Treasury will step in and provide necessary liquidity during times of extreme market stress or financial insecurity. They are also able to secure excellent interest rates, rates that are typically more advantageous than those available to private mortgage investors.
Freddie Mac and the 2008 financial crisis
Almost from the moment of inception, Freddie Mac was fulfilling its mission to banks and borrowers, providing investors with profitable returns and ensuring healthy market liquidity. As intended, Freddie was a popular vehicle for institutional investment, outperforming many other securities of the time on the secondary market. As a private company, Freddie was able to issue shares to the general public on the NYSE beginning in 1989. Throughout the decade, Freddie continued to provide the housing market with an invaluable service, resulting in ever-increasing revenues and a stock price that tripled in 1991.
Unfortunately, a series of risky trades and a systemic lack of oversight led to the subprime mortgage crisis of 2008, causing undue stress to the housing market and pushing Freddie to the brink of insolvency. The rippling effects through the broader economy were even more concerning. Congress and Treasury Secretary Henry Paulson decided the only way to prop up the Federal Housing Loan Mortgage Corporation was through a massive bailout.
The housing market was at an inflection point. Given the widespread foreclosures and overall financial disruption, Freddie Mac (and Fannie Mae) came under incredible scrutiny by lawmakers demanding to know how and why this housing crisis became an overriding economic crisis.
As the federal government pumped hundreds of billions of dollars into Freddie Mac, a consensus decision emerged to put the company into conservatorship under the watchful eye of the FHFA (Federal Housing Finance Agency). Going forward and until further notice, Freddie would deliver its profits to the U.S. Treasury as part of the payback agreement.
While existing shareholders challenged the legitimacy of this arrangement in court, Freddie Mac’s day-to-day business soon continued much like before to the relief of both lenders and homebuyers across the country. Now, more than 10 years after the housing crisis and the Great Recession that followed, Freddie Mac is more successful than ever. While the company still remains under conservatorship, it’s ranked No. 41 on the 2020 Fortune 500 list of the largest United States corporations by total revenue, and has $2 trillion assets under management.
Freddie Mac and mortgage-backed securities
While it should be made apparent to borrowers sometime during the mortgage process, many individuals, in fact, don’t realize that the conventional loan they are paying back is actually owned by Fannie Mae or Freddie Mac—not the bank or the mortgage company who provided the loan. If you’re unsure, you should go online to see who owns it.
This whole process can seem perplexing at first until you understand the underlying reasons behind increasing market liquidity and why lenders rely on the financial power of enterprises like Freddie Mac. By funding the lender and creating mortgage-backed securities, Freddie helps provide the basis for profit and stability within the lending sector.
When Freddie Mac purchases a mortgage loan from an approved lender, three things happen:
- Freddie takes ownership of the note that is secured by the collateral, which is the homel. Freddie’s business interest is in owning the note—not in owning the property.
- Because the lender has been made whole from this transaction and removed the cost of the loan from its balance sheet, the lender now has fresh capital with which to continue funding additional mortgages with.
- The lender typically continues to service the loan (collect payments). The lender then makes payments to the investor. Freddie does not service loans. That's why ownership of the loan is generally transparent to the borrower.
In the course of everyday business, Freddie Mac is buying up hundreds of loans. Rather than just collecting fees on these mortgages until the borrower repays in full or decides to sell, Freddie bundles similar loans together to form a mortgage-backed security (MBS). The security is then sold as shares to interested investors on the secondary market, or bond market. Typically, these investors include pension funds, mutual funds, hedge funds and insurance companies.
MBS: Logic and risk
Mortgage-backed securities have allowed Freddie Mac to be profitable while at the same time fund billions of dollars worth of mortgages to promote homeownership. Lenders can loan to new homeowners with confidence knowing that in the event of a mortgage default (leading to foreclosure) that Freddie will guarantee funds to investors on the secondary market and ensure the consistent flow of capital throughout the mortgage industry. To be clear, Freddie does not pay a homeowner’s loan in the event of default.
Furthermore, since Freddie guarantees payments in the event of a default—for a fee—institutional investors on the secondary market don’t have to worry about credit risk, making mortgages a particularly attractive investment. With the implicit backing of the U.S. Treasury, and guarantees to both investors as well as lenders, Freddie Mac has become indispensable in ensuring fluidity in the mortgage sector—a function as essential today as it was during the New Deal era.
Today, Freddie Mac boasts an intricate risk management framework that acts as a firewall against systemic problems like those that manifested in the run-up to the 2008 housing collapse. Of course, an MBS will always carry a certain degree of risk. It’s this small degree of risk that the lender, Fannie Mae (and ostensibly the Treasury Department), are willing to take in an effort to fulfill the original chartered mission of providing ongoing liquidity to expand and stabilize the U.S. housing market and increase accessibility for homebuyers.
Freddie Mac loan guidelines and key programs
Freddie Mac is not interested in buying every loan—only those loans that meet its criteria. In an effort to create up-front transparency and provide prudent risk management, Freddie long ago established a set of guidelines for the different types of loans it purchases from approved lenders. These guidelines are highly detailed and cover a range of loan products for conventional loans, first-time homebuyer loans, loans with low- to moderate-income requirements, refinances and more. All in all, Freddie Mac guidelines total more than 2,000 pages.
Conforming loan guidelines
Understandably, these guidelines are too extensive to cover here in any kind of detail; however, if you are seeking a conventional mortgage, it can be useful to familiarize yourself with some of the general conforming loan guidelines for both Freddie and Fannie. Conforming loans are almost always preferred by lenders due their ability to be repackaged as an MBS and sold on the secondary market.
Some basic Freddie Mac guidelines single-family properties are as follows:**
- Mortgage price: limits vary by state, but for 2021 the figure cannot exceed $548,250 for properties not located in designated high-cost areas.
- Minimum credit score requirement: typically 620
- Down payment requirements: certain home loans require options as little as 3% down
- Private mortgage insurance: typically required when down payment is less than 20%
- Debt-to-income ratios (DTI): generally up to 43% is permissible for loan approval
Note: These are general guidelines, alway check with your lender to discuss your unique financial position and consider using a trusted mortgage calculator to explore costs. Sometimes compensating factors such as a high down payment or a large amount of assets can offset DTI weakness, for example.
With at least 33 mortgage-related products, Freddie Mac has a wide portfolio of loans that cover a range of potential borrowers. Additionally, the FDIC Affordable Mortgage Lending Guide lists the following programs, many of them core offerings of Freddie Mac:
- HomeOneSM: Low down payment financing for first-time homebuyers with no geographic or income restrictions
- Home Possible®: Low down payment financing with discounted fees for creditworthy LMI borrowers, first-time homebuyers and retirees
- Construction Conversion and Renovation Mortgage: Financing that covers property purchase and renovation/construction costs in a single mortgage
- Manufactured Home Mortgage: Financing for manufactured homes that uses the credit standards of the home mortgage market
- Freddie Mac Enhanced Relief Refinance (FMERR): Helps borrowers with good payment records who have little or no home equity refinance into more affordable mortgages
Homeownership is a key component of the American dream and the leading way to build generational wealth. However, banks and mortgage companies alone can’t provide the full financial might to fund every last loan. That’s why GSE’s play such an important role within the mortgage industry.
By leveraging its unique and time-honored relationship with the U.S. Treasury, Freddie Mac is able to provide affordability to the homeowner, liquidity to the lender and overall stability to the housing market. As long as guidelines are adhered to and high-risk trades are avoided, the contributions of The Federal Housing Loan Mortgage Corporation will continue to have a salutary effect on the broader economy—and in people’s lives.
**Guaranteed Rate, Inc. is a private corporation organized under the laws of the State of Delaware. It has no affiliation with the US Department of Housing and Urban Development, the US Department of Veterans Affairs, the US Department of Agriculture or any other government agency.
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