Freddie Mac: Understanding Loan Guarantees And Their Benefits

Freddie Mac is a government-sponsored enterprise that provides liquidity, stability, and affordability to the mortgage market. It purchases mortgages from lenders, allowing them to provide financing options to qualified borrowers. Freddie Mac then securitizes these mortgages into mortgage-backed securities (MBS) and sells them to investors. The company guarantees the principal and interest payments on the MBS, making them a relatively safe investment. In addition to its role in the mortgage market, Freddie Mac also offers loans and grants for various purposes, including single- and multifamily housing, community facilities, and essential services in rural areas.

Freddie Mac's guarantee fees

Freddie Mac is a government-sponsored enterprise (GSE) that helps ensure a stable supply of financing for residential mortgages. It buys mortgages from lenders and pools them to create mortgage-backed securities (MBSs), which it sells to investors and guarantees (for a fee) against losses from defaults. This fee is known as a guarantee fee.

Freddie Mac's primary method of making money is by charging a guarantee fee on loans that it has purchased and securitized into MBS bonds. Investors are willing to let Freddie Mac keep this fee in exchange for assuming the credit risk. That is, Freddie Mac guarantees that the principal and interest on the underlying loan will be paid back regardless of whether the borrower repays. Owing to this financial guarantee, these MBSs are particularly attractive to investors.

Freddie Mac's credit-risk transfer activities may eventually lead to a reduction in the guarantee fees that mortgage lenders pay to the government-sponsored enterprise. According to CEO Donald Layton, if the credit-risk transfer activities continue to grow, the guarantee fees could become lower in the long run. As of 2018, the guarantee fee business still largely fuelled Freddie Mac's earnings.

Conforming loans

Freddie Mac is a government-sponsored enterprise that provides liquidity, stability, and affordability to the mortgage market. It is ranked No. 45 on the 2023 Fortune 500 list of the largest United States corporations by total revenue and has $3.208 trillion in assets under management.

Freddie Mac makes money by charging a guarantee fee on loans that it has purchased and securitized into mortgage-backed security (MBS) bonds. Investors are willing to let Freddie Mac keep this fee in exchange for assuming the credit risk. That is, Freddie Mac guarantees that the principal and interest on the underlying loan will be paid back regardless of whether the borrower actually repays. Owing to this financial guarantee, these MBS are particularly attractive to investors.

Government backing

Freddie Mac is a government-sponsored enterprise that provides liquidity, stability, and affordability to the mortgage market. It was established by Congress in 1970 as a private corporation through the Emergency Home Finance Act. The Act's purpose was to provide competition for the newly privatized Fannie Mae and to increase the availability of funds to finance mortgages and home ownership.

Freddie Mac's primary method of making money is by charging a guarantee fee on loans that it has purchased and securitized into mortgage-backed security (MBS) bonds. Investors are willing to let Freddie Mac keep this fee in exchange for assuming the credit risk. That is, Freddie Mac guarantees that the principal and interest on the underlying loan will be paid back regardless of whether the borrower repays. Owing to this financial guarantee, these MBS are particularly attractive to investors.

Freddie Mac and Fannie Mae are unique entities in their company structure. Their close relationship with the federal government gives them access to lower borrowing costs and more investor confidence due to an "implicit guarantee". Many assume the government will intervene before letting the GSEs default, even though there is no explicit guarantee. For example, during the late 1970s and early 1980s inflation and recessions, the federal government helped Fannie Mae recover from its financial losses with regulatory forbearance and tax benefits.

In 2008, during the financial crisis, the federal government intervened again to prevent a wider economic fallout. Congress passed the Housing and Economic Recovery Act, establishing the Federal Housing Finance Agency (FHFA) and giving the U.S. Treasury the authority to advance funds to stabilize Fannie Mae and Freddie Mac. The U.S. Treasury's debt ceiling was raised by $800 billion in anticipation of the need to support the GSEs.

Rural housing

Freddie Mac provides loans, grants, and loan guarantees for single- and multifamily housing in rural areas. The company's Single-Family Division keeps mortgage capital flowing by purchasing mortgage loans from lenders so they can continue lending to qualified borrowers.

Freddie Mac purchases assumable and non-assumable GRH loans through its Fixed-rate Cash, Fixed-rate Guarantor, and MultiLender Swap executions. The USDA's Rural Housing Service (RHS) Section 502 Guaranteed Rural Housing (GRH) Loan Program helps meet the needs of rural borrowers who have the necessary income and credit history but not the down payment required for a conventional mortgage.

The RHS also offers a variety of programs to build or improve housing and essential community facilities in rural areas. These include loans, grants, and loan guarantees for single- and multifamily housing, childcare centers, fire and police stations, hospitals, libraries, nursing homes, schools, first responder vehicles and equipment, and housing for farm laborers.

Freddie Mac's Multifamily Division provides liquidity and stability to the rental housing market, improving access to quality, affordable housing. The company finances rental housing across the nation, including in smaller communities, to fund multifamily rental properties with five or more units. In 2022, Freddie Mac's targeted affordable housing loans increased by nearly 60%, totaling $15.3 billion. Of the 693,000 rental units financed through loan purchases, more than 420,000 were affordable to low-income households earning up to 80% of the Area Median Income (AMI).

Freddie Mac also offers innovative solutions to increase access to affordable housing in rural communities. For example, the CHOICERenovation mortgage offering allows lenders to deliver loans to Freddie Mac where the borrower uses the loan proceeds to pay for renovations. Additionally, the company provides resources and support to help more Native Americans achieve their homeownership goals.

Risk management

Freddie Mac is a government-sponsored enterprise that provides liquidity, stability, and affordability to the mortgage market. It purchases mortgages on the secondary market and pools them into mortgage-backed security (MBS) bonds, which are then sold to investors. This process injects liquidity into the mortgage market and makes MBS a relatively safe investment.

Freddie Mac guarantees the principal and interest payments on the MBS, making them attractive to investors. The guarantee fee on these loans is Freddie Mac's primary method of making money. This guarantee is not an explicit guarantee by the US government, but the close relationship with the federal government gives Freddie Mac access to lower borrowing costs and more investor confidence. This is known as an "implicit guarantee".

However, in the years leading up to the 2008 Financial Crisis, Freddie Mac started investing in riskier loans, contributing to a housing bubble. They purchased large volumes of Alt-A mortgages, which had higher loan-to-value (LTV) and debt-to-income (DTI) ratios and often lacked full documentation of borrowers' incomes. As a result, when the housing market collapsed in 2007, Freddie Mac lost billions of dollars and investor confidence eroded.

To maintain its operations and stability, Freddie Mac continuously updates its risk management requirements to address evolving risks in the mortgage and related industries. These updates are designed to manage risks associated with its Seller/Servicer relationships and transactions and to minimise any potential impact on borrowers in the event of conflicts or adverse events. The company also offers an array of educational resources to help homebuyers make informed decisions and support their financial capability and homeownership journey.

Freddie Mac also has a dedicated team for risk management, with roles such as Counterparty Credit Risk Management Associate/Senior, Model Risk and Control Oversight Senior, and Compliance Risk Manager. These roles are responsible for managing and mitigating the various risks associated with Freddie Mac's operations.

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