By Kenneth R. Harney
Saturday, May 24, 2008

Could the mortgage industry scrap its controversial practice of listing hundreds of local real estate markets as "declining" -- and restricting lending there through higher down payments or credit scores?

The two biggest players in the home mortgage field, Fannie Mae and Freddie Mac, did precisely that last week. Reversing its policy of penalizing buyers in troubled real estate markets with five-percentage-point higher down payments, Fannie Mae switched to a policy of requiring the same minimum down payments irrespective of location. Freddie Mac spokesman Brad German said his company will be "suspending" its declining-markets policy indefinitely, too.

Starting June 1, mortgage applicants who are underwritten by Fannie Mae's automated system online will qualify for a 3 percent minimum down payment, wherever the property is. Borrowers whose applications require "manual" underwriting will have a 5 percent minimum.

Under Fannie Mae's previous system, applicants buying houses in designated declining markets had to contribute five percentage points extra in upfront equity compared with borrowers in nondeclining areas.

Freddie Mac did not use a list of specific areas designated as declining; it relied instead on lenders to flag applications using appraisal data or home-price indexes. For those applicants, it also required the same increase in equity contributions upfront.

Critics, including the National Association of Realtors and consumer advocacy groups, had charged that Fannie Mae's policy served to further depress sales and real estate values in areas tainted as declining.

Critics also argued that many metropolitan markets experiencing price decreases contain submarkets performing relatively well and do not deserve to be underwritten as high risk.

Marianne Sullivan, Fannie Mae's senior vice president for single-family credit and risk management, said the policy reversal was possible because of improvements to the company's automated underwriting system allowing it to "assess each loan more precisely" wherever the property is.

The change was welcomed by national real estate and housing groups. Dick Gaylord, president of the National Association of Realtors, said the termination of a policy that "stigmatized" certain communities will "help stabilize the credit markets."

David Berenbaum, executive vice president of the National Community Reinvestment Coalition, said his group hopes the revised policies will be "a model for others to follow."

Whether that happens anytime soon is far from certain. Almost all private mortgage insurers, which provide loss protection to lenders on loans with low down payments, have adopted highly restrictive policies affecting Zip codes or metropolitan areas they designate as distressed or declining.

MGIC, the largest-volume mortgage insurer, recently expanded its list of distressed markets along with a series of cutbacks on specific types of low-equity loans. As of June 1, MGIC will not insure mortgages on condominium units in Florida. It has also abandoned cash-out refinancings and loans on investment properties.

PMI Group, another major insurer, has banned cash-out refis and investor loans in areas it judges to be distressed. Genworth Financial will not consider applications on second homes anywhere in Florida. AIG United Guaranty no longer will write insurance on condominiums in any of hundreds of Zip codes around the country that are on its declining-markets list.

Asked whether his firm might reevaluate its declining-markets restrictions in light of the abrupt changes at Fannie Mae and Freddie Mac, Terry Souers, a spokesman for Genworth Financial's mortgage insurance unit, said, "We're aware of their actions and will take them into consideration to see if additional steps are necessary."

But Michael J. Zimmerman, senior vice president for investor relations at MGIC, said his company has no immediate plans to abandon declining-market restrictions.

"We're not contemplating any changes," he said. MGIC, which reported a $1.4 billion loss for the fourth quarter of 2007 and a $34 million loss for the first quarter of this year, has been hit hard by claims following foreclosures and extended delinquencies in once-booming housing markets.

What's the trend here? Fannie Mae's and Freddie Mac's policy switches should open the door to some additional low-down-payment mortgages -- and home sales -- in areas once tagged as declining.

But without the participation of private mortgage insurers -- who report solely to stock market investors rather than Congress -- many borrowers will probably have to turn to the Federal Housing Administration, which accepts 3 percent down and does not have declining-market restrictions.

Kenneth R. Harney's e-mail address isKenHarney@earthlink.net.