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Freddie Mac (FHLMC): What it is and how it affects your mortgage

Peter Miller
The Mortgage Reports contributor

What is Freddie Mac?

Freddie Mac — officially the Federal Home Loan Mortgage Corporation (FHLMC) — is one of two major players in the secondary mortgage market. The other is Fannie Mae.

In essence, Fannie and Freddie buy mortgages from lenders. In turn, those lenders have more money available to finance home purchases.

The two organizations make homeownership possible for a huge number of mortgage applicants in the U.S. About 66% of them, in fact.

Freddie Mac and Fannie Mae are also part of the reason American homeowners enjoy generally low interest rates on mortgages.

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What does Freddie Mac do?

Freddie Mac is a huge player, not only in the mortgage industry but in the larger economy as well. Among U.S. corporations, Freddie is 40th by revenue according to Fortune. The bigger Fannie Mae is 22nd.

Both Freddie and Fannie do roughly the same thing. They buy mortgages from lenders. The mortgages are then bundled together to create mortgage-backed securities (MBS). MBS interests are sold to investors worldwide.

The buying and selling of mortgages happens on the so-called “secondary market.” This is an electronic platform that brings mortgage money to every location in the United States.

In doing so, the secondary mortgage market frees up money in the primary mortgage market, so that banks and lenders are able to originate more loans for home buyers.

How Freddie Mac and the secondary mortgage market work

It helps to picture Freddie, Fannie, and the secondary mortgage market in more concrete terms.

Think about a local bank. It has $10 million to invest in local mortgages. If the typical mortgage amount is $200,000, then the bank can originate 50 loans. ($200,000 x 50 = $10 million.)

If you’re potential borrower number 51 in this scenario, there’s no lending money left for you.

That’s where the secondary market becomes important.

The above bank takes its 50 mortgages and sells them on the secondary market to the highest bidder. In many cases, that bidder will be Freddie Mac. The bank now has new cash and can continue making local mortgages.

There are obvious benefits to this system. Banks have an ongoing cash flow, consumers are able to buy homes, and the real estate market stays afloat.

In addition, Freddie Mac sells MBS interests to investors worldwide. This bringing additional capital into the US. More capital — more supply — pushes down interest rates. That’s good news for mortgage borrowers.

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How Freddie Mac impacts your mortgage eligibility

Borrowers think of a mortgage as a source of debt. But in the secondary market, a mortgage is actually an asset that can be bought and sold.

Buyers in the secondary market want to make sure the mortgages they purchase represent as little risk as possible. And one way Freddie Mac and Fannie Mae reduce risk is by setting guidelines for the types of loans they’ll purchase and sell.

Those guidelines, which run more than 2,000 pages in total, set the standard for which mortgages are considered a “safe” investment. Borrowers often need to meet them to be considered eligible applicants.

In other words, Freddie Mac and Fannie Mae play a big role in determining who gets a home loan and who doesn’t.

Freddie Mac loan guidelines: conforming and conventional mortgages

Mortgages that meet the guidelines established by Freddie Mac and Fannie Mae are known as “conventional” or “conforming” loans.

To give just a few examples, Freddie Mac and Fannie Mae’s guidelines for conforming loans dictate:

  • The size of the home loan (limits varies by state)
  • Minimum credit score requirement (usually 620)
  • Down payment requirements (can be as low as 3%)
  • Private mortgage insurance (required with less than 20% down)
  • Debt-to-income ratios (generally up to 43% is allowed)

Lenders generally prefer to make conforming loans so they have the option to sell them in the secondary market.

That might seem limiting for buyers who don’t fit in the Fannie/Freddie box. However, conforming guidelines are often quite flexible.

There are standards and requirements, yes, but there are also exceptions, often in the form of “compensating factors.”

For instance, maybe you have a lot of monthly costs and a high debt-to-income ratio (DTI). It might seem as though your loan application will be denied. But, maybe, you have compensating factors that offset a steep DTI — like a big down payment or a lot of cash in the bank.

For those that don’t meet conforming loan guidelines, there are options. Mortgages backed by the government, like FHA, VA, and USDA loans, often have different standards for applicants.

Some lenders also create special mortgages that are non-conforming. Lenders keep these so-called “portfolio” loans until repaid. Portfolio loan standards may be much different (and easier to meet) than the standards for a conforming mortgage.

Flexible home loans backed by Freddie Mac: the Home Possible mortgage

Freddie Mac’s Home Possible mortgage program is an example of real estate financing outside the usual guidelines.

  • Only 3% down required
  • You can qualify for the program even without a credit score
  • Up to 30% of the borrower’s income can come from rent, perhaps from a boarder or roommate
  • Investors are welcome
  • A lender can provide a gift to the borrower

You can get more Freddie Mac information from loan officers. Shop around for the best rates and terms.  Ask about special programs that might be especially good for your situation.

Is Freddie Mac owned by the government?

Freddie Mac and Fannie Mae were both created by the federal government. Each company now has private shareholders.

However, in 2008, Freddie and Fannie were placed into government conservatorship. Today, we often call them GSEs or “government-sponsored enterprises.”

According to ProPublica, the federal government advanced $71.6 billion to Freddie Mac and has so-far gotten back $122 billion.

Should the companies be in a conservatorship? Should the Feds have collected more than $100 billion from the two companies? Such questions are now in court, with answers yet to come.

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