FHFA Announces Relaxed Mortgage Guidelines to Help More Home Buyers
October 23, 2014
This week Mel Watt, Director of the Federal Housing Finance Agency, which regulates Fannie Mae and Freddie Mac, announced policy changes that would allow more homebuyers to obtain mortgages. This move should provide a much needed boost to the housing recovery.
From 2003 to 2007 Fannie Mae and Freddie Mac loosened up their guidelines so much that too many people who were not qualified to buy a home were buying homes they could not afford. Then in 2007 after the market began to crash they substantially tightened up their guidelines. Now they realize that they over-tightened the guidelines so they are loosening them up again. This is a classic case of an overreaction. It has not been announced exactly when the changes will take effect but it is likely that it will be the first of the year.
The most exciting change is that they will offer mortgages for as little as 3% down instead of 5%.
Although FHA does offer a 3.5% down payment option, it is much more expensive to get an FHA loan because of upfront premiums and the high mortgage insurance.Home buyers who use FHA loans pay an upfront premium of 1.75%. These fees add up, so a 3% loan backed by Fannie/Freddie would actually be much cheaper for borrowers.
Watt also announced other policy initiatives to loosen mortgage purchase guidelines to encourage lenders to offer mortgages to more borrowers, even those with less than perfect credit.
Fannie Mae and Freddie Mac don’t directly offer mortgage loans but instead buy the mortgages from banks, credit unions, and other financial institutions so that they, in turn, can lend to more homeowners. In order for lenders to sell their loans to Fannie/Freddie, they must adhere to standards or risk being forced to buy the loans back.
After the housing crisis, Fannie/Freddie tightened their purchasing rules. The problem has been these rules that banks must follow to sell mortgages back to Fannie/Freddie are so strict banks imposed their own rules—called “overlays”—that are even stricter for borrowers. This way banks didn’t have to face the risk of buying the loans back or in some cases face a lawsuit from Fannie/Freddie if the loans are bad. Currently Fannie /Freddie loans require a minimum FICO credit score of 620 to qualify, but most lenders are averaging a credit score of about 740 on loans, which proves that mortgage companies are being a lot more strict than needed simply out of fear of Fannie and Freddie. Banks don’t want to get forced to buy back the loans if there’s an issue so many have raised the credit score requirement way above the Fannie/ Freddie requirement to reduce their risk.
Even though interest rates are currently the lowest rates have been in 18 months, many borrowers have not been able to get loans because of these bank-imposed overlays, resulting in a decline in home sales and a slowdown of the housing recovery. In fact home sales have been down 6 out of the past 9 months this year in Massachusetts and are down nationally as well.
The FHFA has finally recognized this, prompting Watt’s announcement this week at the Mortgage Bank Association’s annual conference in Las Vegas.
Watt said one of the key initiatives was to revise these rules to provide clearer guidance for lenders to manage their risk. Watt also said they were working to develop “sensible and responsible guidelines for mortgages with loan to value ratios between 95 and 97 percent” to “increase access for creditworthy but lower-wealth borrowers.”
For many borrowers a change from having to come up with 3% down instead of 5% could mean the difference between being able to purchase a home and having to put it off. For example, a 5% down payment on a $300,000 home would be $15,000, while a 3% down payment would be considerably lower: $9,000. This would be welcome news for the housing market as more borrowers will be able to purchase a home and take advantage of low interest rates before they go back up. Watt said he would outline the details of these changes in the next few weeks.