What it means
Freddie Mac was created by Congress in 1970 to widen the market for home loans and to add competition in the secondary market (the market in which existing loans are bought and sold). It is a government-sponsored enterprise, meaning a privately run company with a public mission and a special charter.
Its main sister company is Fannie Mae, which does similar work. The basic process is straightforward.
A bank makes a mortgage to a homebuyer, then sells the loan to Freddie Mac for cash. Freddie Mac pools many such loans into a mortgage-backed security and sells it to investors, promising that principal and interest will be paid even if homeowners default.
For that promise, it charges lenders a guarantee fee, which is one of its main sources of revenue. The loans it buys must be conforming, meaning they meet standards on size, borrower quality and documentation, with a loan size limit that is reviewed annually.
Loans above the limit are called jumbo loans and are funded elsewhere. During the housing crisis of 2008, Freddie Mac and Fannie Mae suffered heavy losses and were placed into government conservatorship, a form of supervised control.
Since then, debates have continued about whether and how to return them to private ownership, so the structure of the companies should be checked rather than assumed. For business readers, the importance of Freddie Mac is that it supports the supply of mortgage funding across the economy.
Changes to its rules, fees or loan limits can affect how easily homebuyers borrow, and therefore the housing, construction and building materials sectors. Freddie Mac also publishes research and data on mortgage rates and housing, and its weekly survey of average mortgage rates is widely quoted in the news.
Business planners in housing-related industries often watch such figures for early hints about demand.
In practice
Real-world examples.
Example
A regional bank makes a $320,000 mortgage and sells it to Freddie Mac the following week. The bank uses the cash to make another mortgage to a new buyer, so it can keep lending without waiting 30 years for repayments. Freddie Mac then bundles it with thousands of similar loans.
Example
A pension fund buys a mortgage-backed security guaranteed by Freddie Mac. Because the guarantee covers payment of principal and interest, the fund treats it as lower credit risk than securities with no guarantee, though it still carries interest rate risk. The fund still monitors prepayment risk, since homeowners can repay early.
Example
A first-time buyer asks her lender why the rate is lower on a loan of $350,000 than on a jumbo loan of $900,000. The loan officer explains that the smaller loan qualifies to be sold to Freddie Mac, which makes it cheaper to fund. The loan officer adds that limits are reviewed each year.
Formula
Calculation
Annual guarantee fee income = unpaid loan balance x guarantee fee rate
Suppose a lender sells a pool of mortgages with an unpaid balance of $300,000,000, and the guarantee fee is 0.50% a year. Annual fee income = $300,000,000 x 0.0050 = $1,500,000.
If a homeowner in that pool defaults and the property is sold for less than the loan, the guarantee fee income helps cover the shortfall. For example, a $200,000 balance recovered at $170,000 leaves a $30,000 loss to absorb.Case study
Seen in the real world.
Pinegate Lending is a fictional mortgage company that had grown quickly by selling loans on the secondary market. Its chief executive learned that the company's loans were being rejected by investors because of missing income documents. Each rejected loan had to be held on the books until the problem was fixed.
The risk team analysed 500 recent loans and found that 40 had been rejected, which is 8%, mostly for the same documentation errors. In this illustrative scenario, the company introduced a pre-sale checklist and a quality control review before any loan was offered to Freddie Mac or other buyers.
Within six months, the rejection rate fell to 2%. The faster sales freed up capital for new lending and reduced interest costs on the funds Pinegate had borrowed to hold loans in the meantime. The chief executive reported the improvement to the board and linked a portion of the loan officers' bonuses to clean first-time submissions.
Watch out
Common mistakes.
- Assuming Freddie Mac lends directly to homebuyers, when it buys loans from lenders and does not deal with borrowers.
- Believing a Freddie Mac guarantee protects the homeowner, when it protects investors in the securities.
- Treating Freddie Mac and Fannie Mae as the same company, when they are separate firms that do similar work.
Questions
People also ask.
Is Freddie Mac a government agency?
No. It is a government-sponsored enterprise, although it was placed under government conservatorship during the 2008 crisis. Its shares and the securities it guarantees are not the same thing as direct government debt.
Why does Freddie Mac matter to businesses?
Its funding of mortgages affects housing demand, which in turn affects construction, furnishings, banks and many other sectors. Builders, estate agents and furniture retailers all feel the effect when mortgage funding tightens.
What is a conforming loan?
It is a mortgage that meets Freddie Mac and Fannie Mae standards for size, borrower credit and documentation and so can be sold to them. Loans that do not conform are usually priced differently because they are harder to sell.
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