What It Is:
The Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac") is a government-sponsored entity that buys certain types of mortgages from banks and uses them to collateralize mortgage-backed securities. Freddie Mac also supplies a variety of periodic housing and mortgage data to the public.
 
How It Works/Example:
Although Congress created it in 1970, Freddie Mac is not a government agency and does not receive federal funding. Like other corporations, it is owned by its shareholders and overseen by its board of directors. The Freddie Mac board has 18 directors; the President of the United States appoints five of these directors.
 
Regulation
The U.S. Department of Housing and Urban Development (HUD) and the Office of Federal Housing Enterprise Oversight (OFHEO) regulate and oversee Freddie Mac. These organizations not only ensure the financial soundness of Freddie Mac, they require Freddie Mac to purchase a certain percentage of mortgages for low- and moderate-income housing, which facilitates mortgage lending in those markets.
 
Freddie Mac and the Lending Process
Freddie Mac does not lend to homebuyers. Rather, it purchases mortgages from lenders. Here's how it works.
 
If a homebuyer demonstrates the creditworthiness and means to get a mortgage from a lender (such as a bank, savings and loan, credit union, etc.), the lender agrees to transfer money to the borrower's account and the borrower agrees to repay the lender according to a set schedule. The lender may then choose to either hold this mortgage in its portfolio or sell it in the secondary mortgage market.
 
Freddie Mac is a major buyer of these mortgages. The lenders receive cash, which in turn allows them to make more loans to other borrowers. And because this creates a steady supply of mortgage funds, the rates for these mortgages stay competitive and mortgages are readily available. This in turn makes homeownership possible for more people.
 
Freddie Mac Securities
Freddie Mac packages the mortgages it purchases into groups (referred to as "pooling the mortgages") with common characteristics (i.e., similar interest rates, maturities, or credit ratings). It then sells securities that represent an interest in these loans. These securities, called mortgage-backed securities, are sold to investors in the open market. With the funds received from these sales, Freddie Mac purchases more mortgages.
 
When the homeowner makes his or her monthly mortgage payment to the original lender or mortgage servicing company, the lender or mortgage servicing company keeps a fee and sends the rest of the payment to Freddie Mac. Freddie Mac in turn takes a fee and passes what's left of the homeowner's payment along to the investors who hold Freddie Mac's mortgage-backed securities.
 
Freddie Mac guarantees the timely payment of interest and principal on its mortgage-backed securities -- that is, if the borrowers do not make their mortgage payments on time, Freddie Mac will still make its payments to investors. It is important to note that the U.S. government does not guarantee Freddie Mac. That is, if Freddie Mac cannot fulfill its obligations to its investors, the federal government has no responsibility to rescue it. However, Freddie Mac does have a line of credit with the government, and investors generally believe that the federal government would not actually let Freddie Mac default on any of its securities. As such, Freddie Mac securities usually have very high credit ratings, and it often can borrow money at very favorable rates.
 
Why It Matters:
Freddie Mac's goal is to promote homeownership by supporting the reliable supply of affordable mortgages in the banking system. It does this in three ways. First, Freddie Mac's purchases of mortgages and its sale of mortgage-backed securities creates a steady flow of cash to mortgage lenders. Second, the increase in the supply of mortgage funds fosters competition in the lending industry, which in turn lowers mortgage interest rates, increases the variety of mortgage products, and lowers loan origination costs. Third, banks that are averse to mortgage lending can be put at ease by knowing that they can sell their mortgages, and thus transfer these risks, to Freddie Mac. All of these outcomes mean more Americans can afford to become homeowners.
 
It is important to note that Freddie Mac is not the only government-sponsored entity that engages in the purchase of mortgages and the sale of mortgage-backed securities. The Federal National Mortgage Association (FNMA) and the Government National Mortgage Association (GNMA) compete with Freddie Mac in various ways and further increase the supply of mortgage funds in the United States.

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