Fannie, Freddie Back to Basics: What does it Mean for You?
Commentators on the sub-prime crisis frequently point their fingers both at banks for being too complacent about risk, as well as consumer for borrowing beyond their means. Government regulators meanwhile, have been largely spared from rebuke, despite their role not only in condoning, but even encouraging Fannie Mae and Freddie Mac to increase their indirect mortgage lending to sub-prime borrowers. While their intentions- to increase affordable housing- were benign enough, this policy unquestionably contributing to the burgeoning of lending to un-creditworthy borrowers.
Now, the Federal Housing Finance Agency is quietly reversing course, and moving to rein in sub-prime lending by raising the standards to 2004 levels. “For 2009, FHFA has proposed notching down the companies’ benchmark for buying or guaranteeing mortgages of low- to moderate- income buyers to 51% from 56% in 2009. Meanwhile, the agency has proposed lowering the goal for underserved areas to 37% from 39%.” The implication is that sub-prime loans will be significantly harder to come by. This would seem obvious, given that banks have voluntarily raised their lending standards since the inception of the credit crisis in order to preserve their capital. However, for as long as Fannie and Freddie are/were willing to buy and repackage subprime mortgages, the banks bore little risk in originating them. Now that the secondary market for such mortgages is shrinking, banks will automatically curtail originating them.
At the same time, Fannie and Freddie are leading the way in implementing the Obama administration’s loan modification program, designed to mitigate foreclosures. “Nearly 70,000, or 20%, of the loans voluntarily modified in the U.S. last year were owned by Fannie or Freddie according to HOPE NOW, an industry group. More than half of those modified during the first three quarters of last year were in re-default after just six months, according to the Office of the Comptroller of the currency.” This is great for homeowners eligible for this program, which are able to modify their mortgages at extremely favorable conditions. Of course, it’s burdensome for taxpayers, which now indirectly own both Fannie and Freddie and are responsible for funding their losses.
If their is any silver lining, it is that the government bailout is enabling both organizations to offer “competitively priced debt for the affordable housing industry.” Consistent with increased government regulation and a climate of risk aversion, standards are much higher than before. According to an industry journal, “Deals are being underwritten at 75 percent or 80 percent loan to value (LTV) and 1.25x debt-service coverage ratios (DSCRs) in pre-review markets, as opposed to the 90 percent LTV and 1.15x DSCR the program offered. But even for deals in strong markets, Fannie Mae will often only go to 85 percent LTV and 1.20x DSCR, as of late February.” To translate this jargon, sub-prime borrowers must now provide 20% of the equity, and must maintain a debt service coverage ratio of 125% (net income must exceed mortgage principal and interest payments by 25%), a significant jump from before.
In short, the good news is that both organizations are still facilitating mortgages, and capital from investors is still finding its way to home buyers. The bad news for home buyers is that standards are becoming stricter, though not unreasonably so. Even buyers with mediocre credit can still secure a mortgage, provided they meet the requirements.