All three institutions guarantee that payments will be made to
mortgage investors, even when loans go bad. Those guarantees helped
keep the housing market from coming to a standstill during the
darkest days of the economic crisis.
“But the government is taking on a lot of credit risk,” said
Mark Zandi, chief economist at Moody’s Analytics. “So if loans go
bad, it’s on the taxpayer. Everyone would find it preferable if the
private sector were to take more of the risk.”
To that end, the federal government is eager to tackle the “jumbo”
In the District and most of its neighboring counties, a temporary
federal policy allows the government to back mortgages up to
$729,750. Such loans typically carry a lower interest rate than
those without government backing, in part because the federal
guarantee makes them a safer bet for investors.
“Investors are willing to accept a lower return if their
investment is less risky,” said Keith Gumbinger, a vice president at
The Obama administration has supported allowing the maximum loan
limit to drop to $625,500 starting Oct. 1 , and Congress is expected
to back that move. (
Loan limits may be lowered even further for FHA-insured
loans, federal officials said, though no details are available.)
Once the cap is lowered, loans larger than $625,500 will fall into
the “jumbo” category. Jumbos are perceived to be more risky and
therefore often face tougher requirements, such as 30 percent down
payments and stellar credit scores.
Standards might ease if the private sector reenters that market,
said Eric Gates, president of Apex Home Loans in Rockville. But if
the $625,500 cap were in place today, it could lock many potential
buyers out, he said.
Among them is a borrower working with Apex who wants to buy an
$850,000 home in the District. The borrower plans to take out a
$680,000 loan and put down 20 percent.
At today’s average rate on a 30-year fixed-rate mortgage of that
size, the borrower would be charged 5 percent interest. She would
pay $3,650 a month in principal and interest.
If the lower loan limit were in place, that loan would be subject
to jumbo rates, which average 5.6 percent. The borrower’s payment
would jump to $3,904, a $254 increase per month.
If the borrower cannot put down more money or afford higher
monthly payments, she will have to buy a less expensive house —
unless the seller lowers the asking price, Gates said.
Many potential buyers with high-paying jobs could find themselves
in the same situation, Gates said. “This includes lawyers and
doctors who have only been practicing for a few years and also have
several student loan payments that keep them from saving large
amounts of money [for a down payment] quickly,” he said.
Down payments and fees
Standards are not likely to ease on the down payment front.
Borrowers looking to take out FHA loans — the mortgage of choice
in recent years for cash-strapped borrowers — could see the minimum
down payment requirements rise from 3.5 percent, the administration
said in a report to Congress last month.
Also, Fannie Mae and Freddie Mac should gradually raise their
minimum to 10 percent down, the administration suggested.
Other moves are also geared toward raising down payments for
certain types of loans. A financial regulatory overhaul enacted last
year requires lenders to retain at least a 5 percent stake in the
loans they sell to investors. The law carved out an exception for
FHA-backed mortgages — considered relatively safe — and it directed
regulators to decide by late April if other types of mortgages also
should be exempt.
Those regulators are close to proposing a plan that would extend
that exception to all loans guaranteed by the government, including
those backed by Fannie and Freddie.
Here’s where down payments come in: As part of that upcoming
proposal, regulators plan also to exempt loans with down payments of
at least 10 percent or 20 percent — the exact percentage to be
decided after public comment is gathered.
John Taylor, president of the National Community Reinvestment
Coalition, said that even a 10 percent requirement would hurt buyers
and “make it even more difficult for people to sell houses.”
Community banks and mortgage banks will be at a disadvantage if
either of those options is enacted, said John Courson, chief
executive of the Mortgage Bankers Association. If forced to hold on
to certain loans, these lenders say they would have to make fewer
mortgages, raise interest rates or both.
The costs to borrowers go beyond down payments. The administration
has proposed that Fannie and Freddie raise their “guarantee fees”
over the next several years. When borrowers fall behind or default
on their loans, Fannie and Freddie use these fees to pay their
mortgage-bond holders. The fees are usually included in interest
rates paid by borrowers.
The increase of one-quarter percentage point in annual
premiums planned for FHA mortgages is scheduled to take effect April
18. For the vast majority of loans, the premium will rise from 0.9
percent to 1.15 percent. For a borrower who takes out a $170,000
mortgage, the average FHA loan size, the monthly payment would
increase by $34 a month.
“The irony of it is that all of these policies are intended to
protect consumers from bad mortgage practices,” said Guy Cecala,
publisher of Inside Mortgage Finance. “The price of improving and
better protecting them is to increase the cost of the mortgage.”
30-year fixed-rate mortgage
Much further down the line, if Fannie and Freddie are dismantled,
the future of the popular 30-year fixed-rate mortgage comes into
The United State is one of the few countries where most of the
mortgages are prepayable, 30-year fixed-rate loans. That means that
lenders bear the risk of financing a mortgage that borrowers can
then refinance without penalty if rates go down.
With Fannie and Freddie buying the loans, lenders are off the hook
if the loans default. They also do not have to worry about a sharp
rise in rates during the life of the loan.
“The interest rate risk is phenomenal,” Cecala said. “If [lenders]
charge 5 percent interest and then the rates shoot up to 10 percent
for a 30-year [loan], they are losing money on every one of the
loans that they held at 5 percent.”
Lenders would be taking a risk on interest rates going the other
“If the rates drop to 2 percent, everyone refinances and that 6
percent above-market loan you have you lose to refinancing,” said
Adam Levitin, a law professor at Georgetown University.
The question becomes, will lenders lose their appetite for the
30-year loan without Fannie and Freddie there to shoulder that risk?
“I don’t see that happening,” said Brent Ambrose, a real estate
professor at Pennsylvania State University. “When there’s demand,
people will provide it. It may cost a little more, given that the
guarantee is not going to be there, but there will be institutions
out there that will find a way to provide it.”
After all, Ambrose said, 30-year loans are available in the jumbo
market, where loans are not federally backed.
Barry Zigas, housing policy director at the Consumer Federation of
America, said that outlook may prove correct.
“But it’s a hell of a gamble,” Zigas said. “Once you set up the
system without the guarantees, if you bet wrong it’s going to have
heavy consequences for consumers.”
The long-term fixed-rate mortgage is an asset that lenders do not
want to keep on their books, Zigas said. They would rather force
consumers to take on the interest rate risk. That’s why
adjustable-rate mortgages are prevalent in other parts of the world.
With those loans, borrowers bear the risk of rates going up.
Levitin said the jumbo market exists only because it piggybacks on
the Fannie and Freddie infrastructure.
“The 30-year fixed-rate mortgage has been the bedrock of American
housing finance from the Depression up until the beginning of the
housing bubble,” when borrowers went chasing after more exotic
loans, Levitin said. “We have never seen a private mortgage market
in the U.S. provide long-term, fixed-rate loans on a wide scale, and
there’s no reason to think it will.”