Freddie Mac Tightens Home-Lending Rules

By Dina ElBoghdady
Washington Post Staff Writer
Wednesday, February 28, 2007

Freddie Mac, one of the biggest investors in U.S. mortgages, plans to toughen its standards and stop buying certain types of risky loans that have been linked to a high number of delinquencies and defaults.

The decision, announced yesterday, is the latest sign of the deep problems roiling the subprime mortgage market, which caters to borrowers who could not qualify to buy a house with a conventional loan, including people with blemished credit records.

During the recent housing boom, subprime lenders eager to cash in on the home-buying frenzy relaxed their standards. They allowed borrowers to take out mortgages with low teaser rates that ballooned after the first few years. Now that the higher rates are kicking in, many borrowers are struggling to make their monthly payments, and dozens of small lenders are losing money, shutting down or filing for bankruptcy protection.

Freddie Mac's decision to clamp down on these types of mortgages signals heightened alarm about the course of events. If the damage is not contained, a crippled mortgage industry could destabilize the economy, several economists said.

"This is one of the biggest voices in the mortgage market saying in a very public way that the mortgage and housing markets are very troubled," said Mark Zandi, chief economist at Moody's

The trouble is most apparent in the fourth-quarter mortgage delinquency rate, which climbed to its highest level in four years, the Federal Reserve said yesterday. The portion of loan payments at commercial banks that were at least 30 days overdue rose to 2.11 percent in the quarter, up from 1.72 percent in the previous three months. Other measures of mortgage delinquencies have also increased recently.

All indications are that delinquencies are rising faster in 2007. Typically, if there's a surge in delinquencies, defaults follow. Many blame the surge on subprime mortgages, which, according to the Mortgage Bankers Association, made up about one-fifth of all new mortgages last year.

That's why Freddie Mac plans to apply stricter standards to subprime mortgages written on or after Sept. 1, 2007, that have "a high likelihood of excessive payment shock and possible foreclosure."

Freddie Mac executives singled out the so-called 2/28 and 3/27 adjustable-rate mortgages, which offer low rates for the first two and three years of the loan, respectively, and then adjust to a much higher rate for the remaining 28 or 27 years.

Freddie Mac, based in McLean, does not buy many subprime loans directly from lenders, but it is fairly active in investing in securities that are backed by such loans. Freddie holds about $180 billion of those securities and says about half of those would not meet its new criteria.

The company will buy securities backed by the 2/28 and 3/27 loans only if the borrowers qualify for the highest rate the loan can have. For instance, if the teaser rate is 2 percent but eventually kicks up to 8 percent, the borrower must qualify for the 8 percent loan.

"What was appropriate for people in the past is not appropriate under the changed economic circumstances," Richard F. Syron, Freddie Mac's chairman and chief executive, said in an interview.

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