There are few names in the real estate world more recognizable than Freddie Mac and his sister, Fannie Mae. Although these mortgage giants are fixtures of daily chatter around real estate and investment watercoolers everywhere, what they are and why they exist as part of the housing market is a little less commonly known or understood. After all, you don’t need to know what Freddie Mac is all about in order to get a loan backed by this institution, or to invest in it.
What is Freddie Mac?
If you’re already familiar with the Federal National Mortgage Association, otherwise known as Fannie Mae, the Federal Home Loan Mortgage Corporation, or Freddie Mac, is going to sound eerily similar. And it’s for good reason, really. Both are considered a government-sponsored enterprise (GSE). Freddie does much the same thing Fannie does.
Those tasks include purchasing new loans from financial institutions to help free up capital to make even more residential and commercial mortgage loans, bundling those loans into an instrument called a mortgage-backed security (MBS) and selling shares of those securities to investors. This is pretty much exactly what Fannie Mae does, too. That leads to a whole bunch of other questions, like what the actual point of Freddie Mac is if Fannie’s already got this job under control.
There is significant overlap in what Fannie and Freddie do, but Freddie Mac focuses largely on buying mortgages from smaller mortgage lenders and savings and loan associations, thus injecting cash into smaller markets where it can sometimes be difficult to get capital flowing
Why Freddie Mac exists
After its creation in 1938, Fannie Mae became a wildly successful entity, helping to create a stable base for lenders who wanted to make more mortgages with less risk. This led to an overall better supply of easier-to-attain mortgages for homebuyers who needed them, as well as more affordable housing for everyone. Fannie Mae became so successful, in fact, that it was starting to look like it might run up against the many antitrust laws designed to protect customers from giant, powerful corporations.
So, in 1970, the federal government established Freddie Mac as a way to create competition for Fannie Mae. Even though both companies do essentially the same job, buying up mortgages on the secondary market, they’re technically direct competitors who help to keep one another in check. By breaking up which mortgage loan is purchased by which entity, it allowed for potential homebuyers and investors to choose a bank not only based on the loans being offered, but also by which one would be guaranteeing those loans on the secondary mortgage market.
A little competition can be a healthy thing, especially when it comes to being able to influence mortgage lending and mortgage rates and terms. After all, Freddie and Fannie will only buy loans that are made to their standards (this is why they’re sometimes called “conforming loans”), making it impossible for a renegade lender to sell those mortgages to either entity without following specific guidelines.
Freddie Mac in commercial real estate and investment markets
Like Fannie Mae, Freddie Mac buys real estate loans on the secondary market directly from lenders. These loans were originally made to both homeowners and investors. The criteria are similar on the residential investment side, with a maximum unit limit of four for owner-occupied investment properties. Commercial real estate lending guidelines are much more complicated, based on the type of property being purchased. For investors, Freddie Mac can still be your best friend because you’ll be able to take advantage of smaller down payments and potentially better interest rates.
Freddie Mac also creates the same type of mortgage-backed security as his big sister, which can be used as investment vehicles. These are created by bundling mortgages, then dividing that bundle into smaller pieces that contain a little bit of each of the mortgages in the bundle.
In their most basic forms, as each mortgage payment is made, an investor in a mortgage-backed security receives a portion of the combined return. If one mortgage in the bundle is in foreclosure, but the rest are in good standing, the investor is still going to have a gain. This spreads the risk out a great deal and makes mortgage-backed securities a reasonably safe investment for even very conservative investors.
The Millionacres bottom line
Freddie Mac is the lesser known, but every bit as important, sibling of Fannie Mae. Although Freddie generally buys mortgages from smaller banks, this is arguably the more important job between the two, since these smaller banks have far less liquidity and are at higher risk of complete obliteration if too many loans go into foreclosure or otherwise turn on these banks. Because Freddie guarantees mortgage purchases, any borrower using these loans also benefits from a lower interest rate and favorable terms.
And, like Fannie, Freddie creates reasonably solid investments in the form of mortgage-backed securities within financial markets. These vehicles allow anyone to invest in the real estate market without having to lay out a lot of capital. They’re great for beginning real estate investors, since the risks are low. Mortgage-backed securities give these investors a chance to slip gently into a world where most investments demand a great deal of research and understanding of market forces to really do well.