One way in particular that it helps both lenders and homeowners is by allowing banks to provide 30-year mortgages. Without the financial backing of Freddie Mac, it would be too risky and expensive for banks to keep loans on their books for that long. Freddie resells the mortgage-backed securities to investors on the secondary market. This allows more investors to profit from the real estate sector. Meanwhile, Freddie uses the proceeds to buy more bank mortgages.
How Freddie Mac Works
Marc Edelstein, a senior loan officer at Ross Mortgage Corporation in Detroit, told The Balance via email that Freddie Mac plays an important role in mortgage lending, and without the entity, lending would look very different. “The role of Freddie Mac is to provide liquidity to the mortgage market since mortgage lenders lend their own money,” Edelstein said. Mortgage lenders don’t have an unlimited supply of money, and they need their reserves replenished if mortgage lending is to continue. So, Freddie Mac buys those loans, freeing up cash for lenders to provide mortgages to other qualified borrowers, Edelstein said. After Freddie Mac buys mortgages from banks and other lenders, it combines similar types of mortgages into bundles called “mortgage-backed securities” and then sells shares of the bundles on the secondary market to insurance companies, pension funds, and other investors. Freddie guarantees that the investors will receive an agreed-upon monthly payment. So, how does this work? Each month, the bank receives your mortgage payment and forwards it to Freddie Mac, which then pays its investors. It doesn’t sell all the mortgages it buys; some of them are kept as investments. Freddie Mac’s involvement in the U.S. economy also produces another benefit. It keeps mortgage interest rates low. And when rates are low, it makes homeownership more affordable.
What It Means for Individuals
By insuring mortgages, Freddie Mac gives lenders more confidence in approving loans. This makes homeownership possible for people who may not have gotten approved without this backing. Before the Great Depression, the private sector financed housing exclusively, and mortgage loans had down payments that were so high, they were often half of the home’s purchase price. In addition, the lenders expected the borrower to pay off the loan in 10 years or less, and there was usually a balloon payment at the end of the term. Federal involvement (first with Fannie Mae in 1938, and later with its brother organization, Freddie Mac in 1970), helped to make loans more affordable for homeowners. All of these actions help stimulate the housing market—which is good for individuals. A healthy housing market results in more residential construction, which leads to more jobs.
Notable Events
Freddie Mac was created by Congress in 1970 and capitalized with a contribution of $100 million to start purchasing long-term mortgages. It was not limited to just purchasing mortgages that had been issued or guaranteed by the feds. In fact, in 1971, Freddie Mac issued the first conventional loan mortgage-backed security. In 1989, Congress enacted the Financial Institutions Reform, Recovery, and Enforcement Act, and reorganized the corporate structure of Freddie Mac to be a for-profit corporation owned by private shareholders. In the second half of 2007, Freddie Mac and Fannie Mae had a combined net loss of $8.7 billion. As a result of the subprime mortgage crisis, which led to the Great Recession, Freddie Mac was unable to guarantee all of its risky loans. In 2008, Congress authorized the Treasury Department to purchase up to $200 billion in its preferred stock. Both Freddie Mac and Fannie Mae were put into conservatorship to remain solvent. By 2012, Freddie Mac began reporting profits, and from 2008 through 2018, it reported a cumulative profit of $31.7 billion. “Freddie Mac and Fannie Mae provide a tremendous amount of stability in mortgage lending,” Edelstein said. “Their guidelines are published, lenders know where to find them, there is very little ambiguity in them, they are ingrained in our industry.”
