If you have any interest in real estate investing, you might probably know about the name Fannie Mae. The largely successful entity became so popular that it led to the formation of another similar entity that goes by the name of Freddie Mac.
Fannie Mae and Freddie Mac are two of the most well-known names among real estate investors. These two aren’t actual people. Rather, Fannie Mae and Freddie Mac are giants in the mortgage industry and are at the center of discussions surrounding real estate investments everywhere. Of course, that does not mean everybody knows what they truly are or why they exist as part of the housing market. The biggest reason why many people don’t know is that you don’t really need to know much about what they are and why they came along to get a loan backed by the institutions or to invest in the mortgage-backed securities they create.
Today, we will tell you everything you need to know about Freddie Mac to help you truly understand what it’s all about.
What Is Freddie Mac?
Freddie Mac is the Federal Home Loan Mortgage Corporation, and it is the younger sibling of Fannie Mae, aka the Federal National Mortgage Association.
These two government-sponsored enterprises (GSE) have a similar name, and they do pretty much the same thing with one significant difference.
Fannie Mae and Freddie Mac purchase new loans from banks to help them free up the capital necessary to create more commercial and residential mortgages. The GSEs then consolidate those loans into a financial instrument called a mortgage-backed security (MBS). Freddie Mac and Fannie Mae sell shares of the MBSs they create to investors.
If the two institutions do the same thing, you must be wondering why they are two separate entities. The work that Fannie Mae and Freddie Mac do overlaps a lot. However, Freddie Mac traditionally focuses on purchasing loans from smaller banks and loan associations instead of sticking to buying loans from larger banks and mortgage lenders like Fannie Mae.
By focusing on the smaller markets, Freddie Mac essentially injects cash into them and can get an adequate amount of capital flowing into the smaller markets.
Why Was Freddie Mac Created?
Freddie Mac was created in 1970, and its creation was based on the success of Fannie Mae. Fannie Mae was created in 1938, and it became successful in creating a stable base for lenders who wanted to provide more mortgages without adding too much capital risk. Fannie Mae’s work made it much easier for potential homebuyers to secure more affordable mortgages and allowed lenders to create a steady supply of mortgages that reduced their risk.
The GSE became so successful that it appeared that it would begin facing issues with antitrust laws that are designed to protect customers from giant corporations that try to exploit them. To make sure that Fannie Mae did not operate in the real estate sector without competitors, the government created Freddie Mac in 1970 to do the same thing but in a different market.
Since both entities purchase loans on the secondary market, Fannie Mae and Freddie Mac are technically direct competitors and keep each other in check.
The advent of two different entities purchasing mortgages means that potential homebuyers and investors can now choose their lenders based on the loans offered and which entity will guarantee those loans on the secondary mortgage market. The creation of Freddie Mac essentially averted the potential antitrust law issues that could have created significant roadblocks for the work Fannie Mae is doing.
Freddie Mac’s Role In Investment & Commercial Real Estate Markets
Freddie Mac purchases real estate loans directly from lenders on the secondary market. The loans were originally made to investors and homeowners. The conditions to qualify are similar for the residential real estate segment, and there is a limit of four for owner-occupied investment properties.
Commercial real estate lending rules are more complex because they depend on the type of property being purchased. If you are a real estate investor, Freddie Mac can be a vital ally for you because it will allow you to benefit from potentially better interest rates and smaller down payments.
Freddie Mac also creates MSBs by bundling mortgages and then dividing them into smaller portions that contain a bit of each of the mortgages in the bundle. As each mortgage payment is made by the borrower, investors who purchase shares of MSBs get a portion of the combined return based on the number of shares they hold.
This method reduces the overall risk because even if one mortgage in the bundle is in foreclosure and the rest are standing strong, investors will see their potential losses from the foreclosed mortgage offset by the better ones in the bundle. Investors will get returns from investing in MSBs regardless of the foreclosure of a few mortgages in the MSB, making it a low-risk investment to have in their investment portfolios.
In A Nutshell
Out of Fannie Mae and Freddie Mac, Freddie Mac is essentially the less popular sibling of Fannie Mae. Despite being not as well known as Fannie Mae, you should know that it might as well be as important as its sibling.
Freddie Mac does not purchase mortgages from big financial institutions like Fannie Mae. However, buying mortgages from smaller banks might be a more important task. Smaller banks do not have the kind of liquidity as their well-established counterparts. It means that the smaller financial institutions are also at a greater risk of going under if too many loans go into foreclosure or turn on them.
Since Freddie Mac guarantees the mortgages for the smaller financial institutions, any borrower who is using these loans will also benefit from the more favorable terms, including lower interest rates.
Much like Fannie Mae, Freddie Mac creates solid investments in the form of MBS in the financial markets. These investment vehicles allow any individual to benefit from the performance of the real estate market without having to put themselves out on a limb with a massive cash outlay.
The securities that Freddie Mac creates effectively offer an excellent opportunity for beginners in the real estate investing world. The investment vehicle offers decent returns without adding too much capital risk. These mortgage-backed securities allow new real estate investors the chance to dip their feet into a space that is notorious for being overwhelmingly complex and requires a great deal of research and understanding of the market.
If you are interested in learning more about how Freddie Mach loans work and whether this is the right option for you, get in touch with Victor Jung. He can help you figure out which loan program offers the most advantage and if you should use it to buy a home. Click here to learn more.