Major changes ahead for mortgage system as U.S. seeks to scale back role in housing

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Washington Post Staff Writer
Friday, March 11, 2011; 12:13 PM

Fundamental changes are probably ahead for the American mortgage system as the federal government pushes to unwind its unprecedented involvement in the housing market.

These changes could significantly raise the down payments demanded by lenders, curtail the availability of long-term mortgages with fixed interest rates, and increase the cost of borrowing in general.

The government's effort to scale back its role in housing could show up in small ways soon. In April, the Federal Housing Administration plans to raise the annual premium it charges borrowers by a quarter of a percentage point. In October, the maximum size of loans that the federal government backs is scheduled to drop to $625,500 from $729,750. The most dramatic proposal - eliminating mortgage financiers Fannie Mae and Freddie Mac - could take five to seven years.

The thinking is that the government cannot sustain its role in the housing finance system. Federally backed loans make up an outsize share of home purchases - about 90 percent - through Fannie, Freddie and the FHA. Taxpayers have kicked in more than $130 billion to cover Fannie and Freddie losses during the housing crisis, and they could be on the hook for more if the FHA depletes its cash reserves, which are already lower than the level required by law.

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."

Loan limits

To that end, the federal government is eager to tackle the "jumbo" loan limits.

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 HSH Associates.

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.

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