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Fannie Mae and Freddie Mac are the two major companies in the mortgage industry of the United States. Whilst almost everyone will have heard of them, there are not that many that understand what they do and what a vital role they play in financing American homeownership. There are few that understand the potential risk that these two companies pose to the entire financial system of America. In this article what they do, their government sponsored enterprise (GSE), their public missions and how they make a profit.

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What They Do

Fannie Mae and Freddie Mac purchase and guarantee mortgages through the secondary mortgage market, but they do not provide mortgages.

Those that originally obtain the mortgage for the average home owner then sell these mortgages to Fannie Mae and Freddie Mac, or they exchange mortgage pools for mortgage backed securities which are backed by those same mortgages but that carry the guarantee of timely payment of the principal plus interest to the security holder. When mortgages are sold to Fannie Mae or Freddie Mac, or the MBSs are sold back to them, this frees up the funds that have been used to obtain the mortgage in the first place and means that the originators can then create further mortgages. Fannie Mae and Freddie Mac also heavily invests in their own MBSs which is known as their retained portfolios.

Government-Sponsored Enterprises

Fannie Mae and Freddie Mac are government sponsored enterprises, and both were created by Congress, Fannie Mae in 1938 and Freddie Mac in 1970. . Both were created by acts of Congress; Fannie Mae in 1938, and Freddie Mac in 1970. Both have the following ties to the Federal Government:

  • Fannie Mae and Freddie Mac are both companies that are made up of 18 members on the board of directors, five of which are appointed by the president of the United States.
  • The secretary of the Treasury is authorized to support their liquidity, and can purchase up to $2.25 billion of securities from each company.
  • Both companies are exempt from state and local taxes.

Due to these ties the market assumes that the securities issued by Fannie Mae and Freddie Mac carry some guarantee of the U.S. government and if anything were to go wrong that the U.S government would step in to bail them out. This is also reflected by how cheaply they can access funding and they are both able to issue corporate debt at far lower yields than any other institution.

Fannie Mae’s and Freddie Mac’s Public Purpose and Mission

In accordance with their policies, Fannie Mae and Freddie Mac have a purpose to provide a steady stream of low-cost funds for mortgages.

The mission as shown on Freddie Mac’s website states that they will provide liquidity, stability, and affordability to the housing market. The mission on Fannie Mae’s website is to expand affordable housing and bring global capital to local communities to serve the U.S. housing market.

Profit-Driven Companies with a Public Mission

There is no doubt that Fannie Mae and Freddie Mac are driven by profits, and this is something that their shareholders demand. They make their profit in two ways: guarantee fee income and retained portfolios.

The guarantee fee income for both Fannie Mae and Freddie Mac means that they keep a certain amount of each mortgage payment that they have guaranteed the investor a timely payment, for example every mortgage can be divided into principal and interest.

Principal and interest, when collected by a mortgage servicer, is then passed onto one of the two companies, such as Fannie Mae. Fannie Mae will then passes the principal and interest along to the holder of the mortgage-backed security; but it will keep a certain percentage of the interest as the guarantee fee in the similar way of an insurance policy. Fannie Mae should be collecting more in guarantee fee income than it is paying to the mortgage backed securities holders.

Fannie Mae and Freddie Mac also holds huge retained portfolios of mortgages and MBSs. This is because they invest heavily in their own -and each other’s securities. Due to the implied Federal guarantee, they are also able to issue debt at yields lower than other corporations to fund their retained portfolios.

Too Much Risk Concentrated in Two Companies with Federal Ties?

Fannie Mae and Freddie Mac plays major roles in the financing of housing. There is a danger in having so much risk concentrated in only two companies as they manage an immense amount of credit and interest rate risk. Many people feel that they pose too large a risk to the economy, and some believe that Fannie Mae and Freddie Mac have an unfair advantage as they can offer rates that are unavailable to other corporations.

Conclusion

In the summer of 2007, the mortgage market with the exception of those guaranteed by Fannie Mae and Freddie Mac halted and this emphasized the importance of the roles played by these two companies. Freddie Mac shocked the market when they announced large credit related loses. However it is yet to be shown whether the benefits Fannie Mae and Freddie Mac create for Americans will outweigh the risks they pose to our entire financial system.

debt choice yes or noDo you think that debt free living is possible? Of course it is. All it really takes is some self control and a good amount of savings to finance whatever you will need in the future.

But does that mean you should pursue this financial condition? Not really. You see, there are good and bad debts that has different effects on your financial future. According to an article published on Bankrate.com, debt is quite a complex idea. It is not all good, but it is also not all bad. The article continued to state that if you want to be smart when it comes to your money, you need to able to differentiate between a good debt and a bad debt. If not, you might find yourself in big trouble in the future. It is said to be a logical difference between the two – a difference that according to the article, is missed by a lot of Americans.

Obviously, you want to be able to identify this difference before you borrow money. But even if you already accumulated the debt, you should still identify which of your debts are good or bad. This will help you create a better strategy to get out of all your credit obligations.

Tips when it comes to paying off your good debts

Let us begin with your good debts. Differentiating your good and bad debts, at this point, will merely depend on the answer to this question: which debts help increase your personal net worth? Anything that will not increase your financial wealth can be considered as a bad debt.

If that is your definition of a good credit obligation, then you can assume that home loans, student loans and business loans are part of the good debts. Anything that will help you increase your money is a good debt. A home loan will help you increase your net worth as you continue to pay it back. As you pay off your home loan, you will be owning more of the home equity.

When it comes to student loans, an education will help you get the skills that you need to be able to ask for a higher salary from your employer. For business loans, well it will help you earn through your own company.

These three are among the debts that you can consider to be good for your financial future – at least, if you pay them off properly.

But how can you do that? Here are two tips when you are dealing with good debts.

Know when to be aggressive in payments or when to put it off.

When we say put it off, that does not mean you will not make any payments at all. There are both good and bad debts that you can pay off aggressively if necessary – without you having to pay a prepayment penalty charge. However, you also have to understand when it is right to be aggressive with your payments and when to be content to just pay the minimum required.

For instance, student loans usually allow you to pay off more than the required amount so you can get out of it faster. But if you still have to build up your emergency fund, then it is better for you to just satisfy the minimum required and allocate your extra money towards your savings. Or it can be sent towards your investments. But if your savings account or your investment turns out to have smaller returns compared to the interest rate on your student loans, then prioritizing your loan payments will save you more money.

Monitor if it is holding back your financial growth.

The next tip is to check if your loans are hindering your financial growth. If the interest rate is proving to be eating off more of your money than it should, then you may want to focus on debt payments so you can get rid of it easily. But if it is not really hindering your financial success, then you can let it run its course as you focus on other financial needs in your life.

For instance, if your home loan is keeping you from moving on to green pastures in terms of your career, you may want to consider getting rid of the house. You can do this by selling it off and letting the new owner take over the payments.

Tips when it comes to paying off your bad debts

In truth, there is not much difference in paying good and bad debts – unless you consider the urgency by which you need to get out of them.

Bad debts are the debts that take money from your pocket without contributing anything towards your financial growth. These include credit card debts, car loans and payday loans.

For credit cards, we usually fall under the trap of buying junk just because we think we can afford it. When you buy through cards, you are using money that is not yours. You have to pay it back and it is usually with high interest. The same is true for payday loans. You will never win with this type of loan because of the high interest rate that you have to pay for it.

In terms of the car loans, this is a tricky debt to be in. Some people believe that it is necessary to make your life comfortable but you also have to remember that it will never increase your personal net worth. A car depreciates as soon as you drive it off the dealer. If you bought it using a loan, you will end up paying more for it than the current value of the car. That makes it a bad debt in our eyes.

So what can you do to help you pay off bad debts more efficiently?

Weigh the debts you need to pay first.

If you have home loans, student loans, payday loans and credit card debts, you may want to consider paying off your credit cards or payday loans first because it has the highest interest rate among all three. You are actually losing more money if you let your card balance run for a longer time. In fact, an article from Kiplinger.com ponts out that sticking to the minimum payments keep us in credit card debt. Do the math and calculate which debts will be costing you more – then you can concentrate on that one.

Know your options to get out of debt.

In case your money will not allow you to pay off your good and bad debts aggressively, you may want to seek out debt relief options that can help you out. You have debt consolidation loans, debt management, debt settlement and bankruptcy as some of your options. See which of them is suited to your specific debt and financial situation.

Understand when it is time to sacrifice your credit score

As you make your choice between the debt relief options, you need to prepare yourself for the time when you need to sacrifice your credit score. When your finances is not enough and you need a debt reduction to handle your bad debts, then your options include debt settlement and bankruptcy. Both of these will damage your credit score to some extent.

Defining good and bad credit accounts

As you work on paying off your debts, you need to learn further how to distinguish good and bad debts. An article from CNN.com defined good debts as purchases that you need but cannot afford to pay in cash. But beyond that, it is also debt that you can afford to pay. On the other hand, bad debts are those that you purchase on credit but you do not really need – at least, not immediately. These are also the debts that you cannot afford to pay back.

To help you distinguish the good loans from the bad loans, here are two questions that you may want to ask yourself.

  • Is it a one time credit purchase or do you see yourself needing this type of credit for a long time? If it is the former, that is a good debt. If it is the latter, that is a bad debt. Although there are certain moments in our lives that require us to borrow money, it should never be a means to support a lifestyle that you cannot afford. If anything, it should help you temporarily – but you need a more solid game plan to finance a need.
  • Is it worth the money you will waste on interest? If yes, then it is a good debt. If not, then it is a bad debt. The benefit of borrowing money to make a purchase is usually convenience and getting something immediately. The downside is you have to waste your hard earned money on the interest.

counselorDo you think credit counseling is the key to get yourself out of debt?

There are a lot of things that you can do to help your quest of becoming debt free. All of them will require you to change your ways as your debts evidently show that you are doing something wrong in your finances. It is important for you to determine the best debt solution that will get you out of debt because there is no one formula to debt freedom. You have to make sure that your financial situation is appropriate for that specific debt relief program. Some people have gotten deeper into debt because they chose the wrong solution for their credit problems. Try not to make the same mistake so you can reach your dream of becoming free from debt.

When it comes to credit counseling, it is an effective way for you to get out of that debt pit that you are in. But you have to make sure that your debt and finances  have the right qualifications to help you solve your credit troubles. According to USA.gov a credit counseling agency will help you negotiate with your creditors so you will be allowed to make lower payments. Then, they will help you send those payments over to the creditors based on the money that you will send them.

But beyond that definition, you need to ask yourself a couple of questions to determine if this is the right debt relief path that you should follow. There are two sets of questions that needs to be asked. One is to yourself while the other set of queries should be answered by the credit counselor.

3 questions to ask yourself before finding a credit counseling agency

Let us begin with the questions that you need to be asking yourself. There are many credit counseling benefits – that is true. But only if you have the right debt types or financial capabilities to complete your payment program.

Given that, what questions should you be asking yourself before you finally opt for credit counseling?

Is it possible for you to do this on your own?

In all honesty, this debt solution is something that the average consumer can do. It is still a difficult task to accomplish, but it is not rocket science. The trick is to have the negotiation skills that will make the creditor agree to change your payment terms. You are not negotiating for a debt reduction – which in essence is actually harder. You are only asking for your payment terms to be revised so you can afford your monthly payments. In most cases, what happens is you propose a longer payment period so you can stretch your contributions thin. That should make the monthly debt payment burden more bearable.

For some people, they may have the negotiation skills but if they do not have the time or the discipline to accomplish this, then hiring a credit counselor is usually the best option for them. Ask yourself if you can negotiate and commit to the payment program that you and the creditor will agree with. That is how you can decide if you can do this on your own.

Is this your best option?

The next question to ask is if this is your best option. Remember that you have other options before you like debt consolidation loan, balance transfer, debt settlement and bankruptcy. You need to determine if this is the best option by looking at your capabilities to pay off your debt. Unlike debt relief options like debt settlement or bankruptcy, there is no debt reduction in this debt solution. You will end up paying for everything that you owe. It is possible for the credit counselor to help you negotiate a lower interest rate – but that is never a guarantee. So make sure that you are capable of paying off your whole debt – even if it is for a longer payment term.

How will your credit score be affected?

You need to ask yourself – how will this debt solution affect my credit score. The good news is, credit counseling hardly has any effect on your score. That is because you will still pay your debts in full in the long run. And since you will be negotiating the payment terms, the creditor will not report you for late payments or default even if you pay lower than what you used to. At least, as long as the amount you are paying is according to what you agreed on in the debt management plan. Some creditors will report that you are currently going through a credit counseling program. That could affect any new credit that you are applying for. But if you finish the program without any problems, then it might not affect your score at all.

5 questions to ask the credit counselor

If the answers to the questions above are in favor of you using credit counseling, then you can go ahead and look for the credit counseling agency that you will use. These questions will help you stay away from debt relief scams, that unfortunately, are still out there waiting for desperate consumers who are burdened with debt.

Here are the 5 questions you need to ask the credit counseling agency that you will get in touch with.

Can you get the information for free?

If it is your best debt solution, then you need to ask if you can get the information for free from the credit counseling agency. According to the Federal Trade Commission website, FTC.gov, a reputable and legitimate credit counseling agency should have no problems sending you information about the company and their services for free. You do not have to provide any information before this is given. If they insist, then you may want to reconsider if this agency is sincerely after your debt freedom or are they only concerned about profiting from your credit problems.

Can you afford to pay according to the debt management plan?

The debt management plan contains your proposed payment terms – usually a lower monthly contribution that is distributed over a longer period. While you will be involved in creating this, it is still bound for the approval of the creditor. But even if that is true, make sure that you do not agree on a plan that you cannot afford. If you end up being unable to pay your debts, you might have the whole agreement terminated, and you do not want that to happen.

What is their procedure in paying off creditors?

In this debt relief program, the credit counselor will be responsible for sending your payments to your creditors. Make sure that their payment methods will not jeopardize the billing cycle of your credit accounts. The debt management plan that you will create should consider the actual schedules of your debts – unless this is part of what the credit counselor will negotiate with the creditors. It is possible to move your payment date after all – you just have to ask the creditor. Just like with the payments, if you miss the schedule that you agreed with the creditor, it will affect the debt management plan.

What fees do you have to pay?

In most cases, you should only pay a maximum of $50 a month for the service that you will get from the credit counselor. Some charge a certain percentage – just make sure that it is no more than 20% of the monthly payment that you are making. Otherwise, you should go and look for another agency to work with.

Who maintain full control over the account?

Even if the credit counselor is the one sending your money towards the creditors, you need to clarify that you will maintain full control of your account. After all, it is still your money. You should be free to get money from it if you want to. Of course, you have to consider the effects that it will have on your debt management plan.

In case you want a list of trusted credit counseling agencies, you may want to look at the accredited list in Justice.gov. This can be a great way to start your search for a legitimate company to work with.

couple discussing over documentsPaying off debt is a must for anyone who wants to improve their lives. Until you free yourself from overwhelming amounts of debt, you will always be held back by the money that you are wasting – paying for your credit obligations and the interest rates associated with it. Debt has a devastating effect to your future so you may want to consider tackling this financial problem before you make any other plans.

According to the latest household debt and credit development report published on NewYorkFed.org, the consumer debt increased by $129 billion in the first quarter of 2014. By the end of March 2014, the debt is now at $11.65 trillion. The biggest part of this debt still comes from mortgages at $8.17 trillion – which increased by $116 billion from the last quarter of 2013. There was also a considerable net increase in the mortgage balance of $233 billion. Next to this, student loans increased by $31 billion. Now, it has a total amount of $1.11 trillion. On a positive note, credit card debt and auto loans decreased to $2.9 trillion and $85 billion respectively. Not only that, the delinquency rate improved during the first quarter of this year. This shows that consumers may be borrowing a lot of money but they are also paying their dues on time.

However, you cannot erase the threat that comes with having a lot of debts. The total amount of credit is still rising. Even if consumers are paying on time, the fact that the balance is increasing and not decreasing puts us in a dangerous position. Soon, the balance might overtake us and make us unable to pay off our debts.

4 non-financial improvements after you get rid of your debt

Of course, we all know that paying off debt is not as easy as it sounds. But it is a necessary thing to do. According to an article from Bankrate.com debt does not only ruin your credit score and finances, it also affects your psyche negatively. It casts a shadow over a lot of areas in your life – your ambitions, confidence and even your relationships. The article even goes on to say that debt can suck out the happiness that you usually get from spending. At least, this is probably true if you are buying stuff using credit.

If you decide to pay your credit balance down, you will get a lot of benefits in your life. The great thing about it is, the benefits go beyond your finances.

In case you want some motivation to paying off debt, you should consider these 4 non-financial benefits to a debt-free life.

  • No stress. At least, you will not have a stressful relationship with your money. Debt brings forth all types of stress in your life that could lead to more serious health problems. If you do not have debt, you do not have to worry about payments that include high interest rates. People who do not have debts are considerably looking a lot better than when they have debts. By reducing the stress in your life, you can lead a healthy lifestyle that will lead you to financial success. That is because you are lowering your chances of getting illnesses that will require you to spend high health care expenses.
  • Secure family ties. Another benefit that you will get from paying off debt is family security. Believe it or not, a lot of marriages failed because of financial issues. After the Great Recession, it was obvious that the main financial issue of families involved debts. By eliminating the stress that debt brings into the household you are actually removing the same stress that could drive you all apart. You do not have to succumb to the blame game. Not only that, you can build your financial cushion so that your family will not have to suffer in case an emergency happens.
  • Better future. Once you have finished paying off debt balances, you will now be in a better position to build up your wealth. You can start saving more or investing so you can finally pursue your dreams. Debt holds you back because it gets you to waste money on interest. Now, you can grab opportunities that will allow you to improve your financial resources so your family can benefit from it in the future.
  • Allows you to be generous. Lastly, being free from debt allows you to become generous in your own way. Now that you do not have to allocate money to pay off debts, you can use some of that freed money to donate to those who are less fortunate than you. That alone will give you so much happiness and fulfillment that cannot be felt with the presence of debt.

An article published on Learnvest.com tells a story of this young woman who freed herself from $30,000 worth of debts. These were mostly credit card debts. When she was forced to face the truth about her financial problems, she decided that paying off debt should be her priority. She changed a lot about her life and habits. After being debt free, she realized she changed so much that she was not totally honest about what she really needed. She can now say no to a lot of her usual expenses and she did not feel deprived at all. She learned that delayed gratification is actually more rewarding in the end. Now that she got rid of her debts, she started saving and has quite an amount in her account. It made her feel good about herself and her future.

You see, the non-financial benefits of paying off debt is actually a lot more satisfying in the end. The lesson you will learn will not only make you wiser, it will also help you avoid a lot of the mistakes that you did in the past.

How debt elimination can help you grow your wealth

But even if the non-financial benefits are better, that does not mean you can underestimate the financial benefits of living a debt free life. To add to your motivation to pay off your credit obligations, here are a couple of things that you will enjoy financially if yo get out of debt.

  • You get to save more. The interest rate of debt is much higher than your savings. So if your extra money goes to paying off debt, then you know that you are actually saving a lot more than you think.
  • You are able to invest. One of the two factors that will help you accumulate financial wealth fast is investing. We have discussed previously that investing is one way for you to use the extra money that is freed by your debt payments. This is one of the direct ways that you can grow your money so it can start earning for you.
  • You are free to pursue opportunities. Not only can you invest, you now have the resources to pursue opportunities. For instance, you can now afford to travel – as long as you budget it properly. That is one way to help you relax and really enjoy your money.
  • You can now choose to use your money wisely. Lastly, after paying off debt, your money is not longer obligated to be sent to your creditors and lenders. You can choose where you want to use it without feeling guilty. You can not act on your fantasies and make your dreams into a reality.

Many investors are faced with a challenging dilemma of whether they should pay off some of their debts with excess cash or whether they should invest this cash further to see whether they can accumulate greater wealth. Paying off too much debt can reduce, if you pay off too much debt and reduce your power to influence a situation to achieve a particular outcome and may see them with not enough assets to retire. On the other hand if you do not reduce debt you could end up losing everything. Therefore when deciding whether to reduce debt or invest it is important to consider all investment options with the risks involved and your current cash flow situation.

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Investment Options

With regards to the numbers the decision you make should be on the after tax cost of borrowing compared with the after tax return on investing. Therefore if you are in the 35% tax bracket and you currently have a 30 year mortgage with a 6% interest rate, you’re actual after tax debt is 4% as you are able to deduct mortgage interest from federal taxes.

Those holding a variety of investments in their portfolio that includes equities and fixed income, they could find that after tax return on the money that they have invested is greater than their after tax cost of debt. If you have a mortgage with a low interest rate and you choose to invest in riskier stocks, investing is the better option. Entrepreneurs may choose to invest in their business rather than reduce debt however those coming to retirement age with a more conservative investment profile may find this reversed.

Risk Tolerance 

When you are determining risk, it is important to consider the following:

  • Age
  • Income
  • Earning potential
  • Time horizon
  • Tax situation
  • Any other criteria that’s unique to you

If you are young and able to make any money you lose you are considered to have a high disposable income with regards to your lifestyle and you possibly also have a higher risk tolerance and able to invest more aggressively rather than paying off debt. However if you have concerns such as high healthcare costs you may also opt to not reduce debt.

You may decide though rather than investing your excess cash you will keep greater cash balances and fixed income investments. The longer you have until you stop working the greater the return that you could enjoy by investing rather than reducing debt this is because historically equities return 10% more pretax over a period of time.

The other component of risk tolerance is whether you are willing to assume the risk. For the aggressive investors they will prefer to invest rather than reduce debt. However if you are the opposite and cannot bear the thought of losing money through investments or having any type of debt you are best to reduce debt. This is a strategy though that can backfire whilst most investors think that reducing debt is the most conservative thing to do, pay off the debt but not eliminating it can have the reverse effect. The best example of this could be an investor who aggressively pays off his mortgage to a very low level is left with very little cash reserves if he then loses his job he will still need to make regular mortgage payments.

Cash and Debt 

It is advised by financial advisors that working individuals should aim to have at least 6 months worth of expenses to hand in case of emergency. It is also suggested that they have a monthly debt-to-income ratio of no more than 33% of pretax income. Once you have secured these then you can look to investing or reducing debt, as you will have that cushion should something unexpected appear.

The first thing you should do is to pay off any credit card debt as this type of debt is likely to carry an interest rate that is higher than most investment earnings. Reducing the debt will save on the amount of interest that you have to pay.

It is worth remembering though some debt such as a mortgage is not a bad debt. If you have a good credit rating the after tax return on your investments will probably be higher than your after tax cost of debt on your mortgage. You also need to take into account the tax advantages that are available on retirement investing, and given the fact that many employers match a portion of the employee contributions it makes sense to invest rather than reduce debt.

Conclusion 

Knowing whether to reduce debt or invest will be dependent not only on the economic environment, but also on the state of your finances.  The best way to tackle this is to have reasonable financial goals and to evaluate the investment options along with the risk tolerance and your current cash flow.