(Corrects Layton's title in paragraph 5)
* Freddie Mac to pay $5.8 billion in profits to taxpayers
* Earnings up on house price gains, better loan performance
WASHINGTON, Feb 28 (Reuters) - U.S. government-run mortgage finance provider Freddie Mac said on Thursday it earned $11.0 billion last year, the first annual increase in its net income since 2006, the year the nation's housing bubble peaked.
The nation's second-largest mortgage finance company, which was taken over by the government in 2008, said it had net income of $4.5 billion in the quarter that ended Dec. 31, 2012, after taking into account a $5.8 billion payment it will make to the U.S. Treasury in return for taxpayer support.
The fourth-quarter profit compared with net income of $2.9 billion in the prior three-month period. The company pinned the increase on gains in home values and fewer mortgage delinquencies.
It was the fifth straight quarter in which Freddie Mac turned a profit.
"It's clear from our earnings that the housing market has turned a corner," Freddie Mac Chief Executive Officer Donald Layton in a statement. "Our work to minimize legacy losses and build a strong new book of business is paying off."
That improved performance was reflected in its annual profit. When it last turned a profit in 2006, its net income was $2.2 billion - just a fifth of what it posted last year.
The company, which has drawn a cumulative $71.3 billion in aid from the Treasury, has already paid back $23.8 billion for the government aid that has kept it afloat.
Freddie Mac and its larger sibling, Fannie Mae, were taken over by the government in 2008 as losses on souring loans mounted.
While losses have eased as the housing market has picked up, the firms still face an uncertain future. Many lawmakers and the Obama administration think the two government-controlled companies should eventually be shut down.
"The big question is what happens now with these profits. It must be very tempting for whoever is in the White House to spend that money," said Phillip Swagel, who served in the Treasury Department under President George W. Bush and is a professor at the University of Maryland's School of Public Policy.
"It is a test for the administration if they are willing to direct these profits towards deficit reduction and not spend them so, eventually, the housing market can be financed with private capital and not just government capital."
Swagel estimates Fannie Mae and Freddie Mac are on track to earn a combined $20 billion a year. He cautioned that policymakers should consider their profitability and dominance and make strides towards comprehensive housing finance reform.
"If that money is spent for other purposes, then it will make it virtually impossible to proceed with reform (of Fannie Mae and Freddie Mac)," he added.
Under an agreement with the Treasury Department, the companies had been required to pay a 10 percent dividend to the government for the taxpayer aid they received. At times, this led them to draw aid just to make the payments.
New terms that took effect this year mandate payments only when they are profitable, but they are now required to turn over most of their earnings.
Fannie Mae has not yet reported its fourth-quarter earnings. The company has already requested $116.1 billion in aid and paid $28.6 in the form of dividends to Treasury. (Reporting by Margaret Chadbourn; editing by Andre Grenon and Dan Grebler)