By: Phillip L. Schulman and Christa Bieker
Earlier this week, Fannie Mae and Freddie Mac announced guidelines for a new mortgage program that will allow down payments as low as three percent for some first-time and low-income home buyers. Melvin Watt, director of the Federal Housing Finance Agency which regulates Fannie and Freddie, explained that the new guidelines will “enable credit worthy borrowers who can afford a mortgage, but lack the resources to pay a substantial down payment plus closing costs, to get a mortgage with 3 percent down.”
Fannie Mae and Freddie Mac do not make loans, but instead buy loans from mortgage lenders and bundle them into securities to sell to investors. Fannie and Freddie’s loan guidelines have broad influence in the mortgage-lending market. The program, first announced in October, is designed to expand access to mortgages with low down payments, which Watt has stated is a “much needed piece to the broader access to credit puzzle.”
Critics of the program caution against mortgages with low down payments, arguing that lax lending standards contributed to the conditions that precipitated the financial crisis. In response, Watt stressed that the new lending guidelines include safeguards, such as required credit counseling, and “provide a responsible approach to improving access to credit while ensuring safe and sound lending practices.”
To qualify for the program the loan must have a fixed rate, and the home must be the borrower’s primary residence. Fannie Mae requires at least one of the borrowers to be a first-time homebuyer. Freddie Mac, in contrast, requires that the borrower’s annual qualifying income not exceed 100 percent of the area’s median income with some exceptions including exceptions for borrowers in underserved and high-cost areas. The program may be available for borrowers with credit scores as low as 620.
In addition, Freddie Mac requires credit counseling for borrowers. Fannie Mae requires credit counseling only in certain instances, such as, when all of the borrowers are first-time homebuyers. Borrowers are also required to obtain mortgage insurance, but are allowed to cancel the premiums once the balance of the mortgage is less than 80 percent of the home’s value. Freddie Mac will also offer a no cash-out refinance option through the program, and Fannie Mae will offer a cash-out refinance option limited to the lesser of 2 percent of the loan or $2,000.
Fannie Mae’s program begins December 13, 2014; Freddie Mac’s program begins March 25, 2015.
Currently, the Federal Housing Administration (“FHA”) insures mortgages with as little as a 3.5 percent down payment. Compared to these FHA-insured mortgages, Fannie and Freddie’s program may be less costly to borrowers. The FHA requires borrowers to purchase mortgage insurance for the entire term of the loan. Fannie Mae and Freddie Mac allow borrowers to cancel their mortgage insurance premiums once the mortgage balance drops below 80 percent of the home’s value, potentially saving borrowers thousands of dollars over the term of the loan.
Despite this advantage, mortgage lenders may be a bit gun shy about making low down payment mortgage loans. After the housing crash, Fannie Mae and Freddie Mac demanded that lenders repurchase billions of dollars of loans that defaulted. The mortgage-lending industry may seek to insulate itself from more forced buy backs and be unwilling to make low down payment mortgages more widely available.
To alleviate the mortgage-lending industry’s concerns and provide the assurances the industry needs to make mortgages more available to borrowers, Fannie and Freddie clarified the circumstances under which lenders will be required to buy back loans. Watt has stated that he hopes to move mortgage finance to a state “that encourages responsible lending to creditworthy borrowers while maintaining safety and soundness of the Enterprises.” Time will tell if lenders are confident enough to embrace Watt’s plan.