A major supplier of mortgage funds, concerned that slowing housing appreciation will increase the likelihood of borrower defaults, pruned back its loan product menu this week.

The Federal Home Loan Mortgage Corp. (Freddie Mac) announced that it will no longer buy loans from lenders who do not require proof of a borrower's employment and income, as well as adjustable-rate mortgages carrying down payments of less than 10 percent.

Lenders often replenish the funds they need to extend home loans by selling mortgages on their books to a secondary mortgage market player like Freddie Mac. Freddie Mac, in turn, pools the home loans into securities, which it then sells as investments.

The reduced-documentation mortgage and the low-down-payment adjustable-rate mortgages are less suitable risks in the face of a dramatic slowdown in housing price inflation, said Michael Stamper, Freddie Mac's executive vice president of risk management. He said Freddie Mac, which guarantees the mortgages it sells, is not experiencing inordinate losses on such loans, but feared it might in the future.

The lending community typically considers appreciating housing values a deterrent to borrowers walking away from their homes and as insurance against losing money on a loan when foreclosed property is sold.

Freddie Mac also announced it is restricting its purchase of several other loan products: mortgages made through mortgage brokers and other third-party sources, second mortgages and certain interest-rate subsidies.

The company will only fund those loan products on a negotiated, case-by-case basis with individual lenders rather than buying them outright, as it does currently.

Earlier this month, Freddie Mac's main competition, the Federal National Mortgage Association (Fannie Mae), quit buying reduced-documentation loans except on a negotiated basis.

The government-owned Fannie Mae already has taken risk-prevention measures with respect to the other loan products no longer as readily available through Freddie Mac, said Robert J. Engelstad, a Fannie Mae senior vice president.

Freddie Mac's loan product cutbacks do not become effective until March 31, but announcement of the company's plans may well prompt lenders to immediately discontinue those types of loans, Stamper acknowledged.

Elliot Schneider, a New York financial analyst at Gruntal & Co. who follows the secondary mortgage market, said the product availability restrictions are long overdue given the risk involved.

The National Association of Realtors, however, was critical of the move. Freddie Mac's retreat from these loan products, charged John Tuccillo, the organization's chief economist, will increase loan costs or delay the mortgage process.

"The scope of opportunity has been cut back by this move," Tuccillo said. "It does not mean that {first-time buyers and purchasers with special borrowing needs} are going to be closed out of the mortgage market, but it is going to be tougher."

Freddie Mac's Stamper disagreed, though, saying that any void can be readily filled by alternatives that pose less risk to the borrower and Freddie Mac.

Borrowers attracted to reduced-documentation mortgages, which account for roughly one-fourth of Freddie Mac's recent loan business, can still make use of alternative-documentation loans, Stamper said.

The reduced-documentation loans eliminate income and employment verification requirements in exchange for a large down payment of at least 30 percent. The alternative-documentation mortgages substitute pay stubs and W-2 forms for employer verifications and tax returns, he said, and are available with as little as a 5 percent down payment.

"We think that the path of alternative documentation will still meet the needs of borrowers who do not fit the cookie cutter, but result in an improvement in the quality of credit," Stamper said.

What's more, he said, borrowers with only 5 percent in cash to put down on a home can still obtain a fixed-rate mortgage that does not expose them to increases in interest rates. An adjustable-rate mortgage with 5 percent down, he added, makes up less than 1 percent of the company's total mortgage portfolio.

The decision to place third-party-originated mortgages under greater scrutiny drew protests from the Mortgage Bankers Association of America. Some lenders avoid the overhead costs of maintaining branch offices by using mortgage brokers and smaller lenders to originate loans.

By refusing to routinely accept third-party loans, the Mortgage Bankers Association said in a statement, Freddie Mac has created the "potential for disrupting the efficiency of a mortgage system" that results in lower interest rates for borrowers.

Tuccillo estimated that third-party loans account for about 25 percent of new mortgages made.

Several of the targeted loan products, Stamper said, do not account for much of Freddie Mac's business. For example, the company has bought "very few" second mortgages outright, he said.

Likewise, the company lately has seen fewer interest-rate subsidies, Stamper said, because the product flourishes when interest rates and inflation rates are high.

The subsidy in question is often referred to as a "3-2-1 buy down." Someone other than the buyer agrees to temporarily reduce the interest rate by placing the necessary funds in escrow at the loan's closing.

Consequently, the interest rate to the borrower is 3 percentage points lower than it would otherwise be the first year, two points lower the second and one point lower the third before returning to the market rate.