Freddie Mac Tightens Home-Lending Rules

When the housing market was robust, subprime mortgage lending was a lucrative business that quickly attracted too many players, said Matthew Howlett, an analyst at Fox-Pitt, Kelton in New York.

When the housing market cooled and interest rates edged up, competition among lenders intensified, Howlett said. Many lenders reached out to even riskier borrowers, relaxed their lending standards and offered more tantalizing terms.

Even exotic mortgages, such as interest-only loans, that were once extended only to the most credit-worthy borrowers were offered to high-risk borrowers as well, layering risk upon risk.

"If you could fog a mirror, you could get a loan," said Brian Horey, a partner at Aurelian Partners, a private investment partnership in New York. "But once property values stopped going up sharply, the true economics of these loans became apparent, and over the last six months, these loans have become undone very quickly."

That's because when the housing market slowed, homeowners could not easily sell or refinance their homes if they had trouble making payments, Horey said.

To protect future borrowers from "payment shock," Freddie Mac will no longer buy securities backed by subprime loans that lack documentation of the borrower's income and the value of the property being financed.

The company also is developing a standard to limit the purchase of securities backed by loans in which the income was stated but not documented.

Freddie Mac also wants lenders to consider the cost of taxes and insurance when they write mortgages.

Fannie Mae, Freddie Mac's larger competitor, said it is waiting for guidance from federal regulators about how to treat nontraditional mortgages.

If lenders and regulators follow Freddie Mac's lead, there would probably be even more people who would not be able to refinance their way out of their problems, which would lead to even more delinquencies initially as the market adjusted itself, several economists said.

The Mortgage Bankers Association questioned Freddie Mac's decision, saying the people who will be hardest hit will be first-time, underserved or minority homebuyers who will suddenly find themselves without access to credit.

"We worry that people who could buy a home today won't be able to qualify for credit in the future if these kinds of subprime loans are driven from the market," said Kurt Pfotenhauer, one of the association's senior vice presidents.

But others are praising Freddie Mac's decision, including Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Committee on Banking, Housing and Urban Affairs, who called on Fannie Mae and the Federal Home Loan Banks to follow Freddie Mac's lead.

"This is a responsible standard that ensures that these borrowers will have the ability to repay their loans, thereby protecting their home equity," Dodd said in a statement. "As I have said repeatedly, there is no justification for providing fewer protections to vulnerable subprime borrowers, who are disproportionately black and Hispanic, and less able to withstand payment shocks."