When it comes to taking out a mortgage, two factors can stand in the way: the price of the mortgage (as in the down payment and the interest rate), and the borrower’s credit profile.
On Monday, the head of the agency that oversees the mortgage giants Fannie Mae and Freddie Mac outlined – in very broad terms – how he plans to make it easier for borrowers on both fronts. Mel Watt, director of the Federal Housing Finance Agency, did not give exact timing on the initiatives. But most of them are designed to encourage the industry to extend mortgages to a broader swath of borrowers.
Here’s what Watt said about his plans in a speech at the Mortgage Bankers Association annual convention in Las Vegas:
DOWNPAYMENTS. Saving enough money for a downpayment is often cited as the toughest hurdle for first-time buyers in particular. Watt said that Fannie and Freddie are working to develop “sensible and responsible” guidelines that will allow them to buy mortgages with down payments as low as 3 percent, instead of the 5 percent minimum that both institutions currently require.
This change would apply to a “targeted segment of creditworthy borrowers” and take into account “compensating factors,” Watt said. (Housing experts speculate that maybe the lower downpayments would only be offered to first-time buyers.) More details to come in the weeks ahead, Watt added.
Fannie and Freddie do not make loans. They buy loans from lenders, package them into securities and sell them to investors.
Both companies used to accept as little as 3 percent down. But Freddie raised the threshold a few years ago, and Fannie followed suit more recently. The boost was part of a broader initiative to shrink the government’s role in the mortgage market — a push that the FHFA abandoned after Watt took over this year. Under Watt, the agency no longer plans to have Fannie and Freddie retreat from the housing market, asserting that both institutions must help keep home loans flowing to the public.
The policies that Fannie and Freddie set for which loans they will buy have huge sway over the mortgage market. It’s unclear if Watt's downpayment plan will do much to ease access to credit. The average downpayment remains lower today than it was in more normal, pre-housing bubble times, said Sam Khater, chief deputy economist at CoreLogic. That’s because the Federal Housing Administration – which backs loans with as little as 3.5 percent down -- has a larger share of the mortgage market than usual, Khater said. Having Fannie and Freddie accept downpayments as low as 5 percent would only help on the fringes, Khater said.
CREDIT SCORES. Most housing advocates agree that a bigger bang for the buck would come from having lenders lower the unusually high credit scores that they’re now demanding from borrowers.
After the housing market tanked, Fannie and Freddie forced the industry to buy back billions of dollars in loans. In a bid to protect themselves from further financial penalties, lenders reacted by imposing credit scores that exceed what Fannie and Freddie require. Housing experts say the push to hold lenders accountable for loose lending practices of the past steered the industry toward the highest-quality borrowers, undermining the mission of Fannie and Freddie to serve the broader population, including low- to moderate- income borrowers.
Today, the average credit score on a loan backed by Fannie and Freddie is close to 745, versus about 710 in the early 2000s, according to Moody’s Analytics. And lenders say they won’t ease up until the government clarifies rules that dictate when Fannie and Freddie can take action against them.
Within the past two years, Fannie and Freddie already had placed some limits on when lenders can be forced to buy back loans. But the industry said the changes did not go far enough and left them exposed to repurchases in cases of fraud and misrepresentation – terms that lenders said are ill-defined.
The most specific comments Watt made Monday aim to address that issue. Watt said Fannie and Freddie will provide clear definitions in the near future. One change that’s coming: Fannie and Freddie would only pursue a repurchase against lenders with a pattern of “misrepresentations and inaccuracies” on several loans rather than a minor problem on a single loan. Again, more details should be released in the near future.
INTEREST RATES. Watt only touched on this subject in passing, but several initiatives under consideration at his agency have the potential to affect interest rates.
One of them involves the fees paid by lenders to Fannie and Freddie. In return for the fees, Fannie and Freddie guarantee the mortgages they buy from lenders and pay investors if the loans default. Since the housing bust, the guarantee fees have been raised several times in part to appropriately price for risk – something both companies failed to do leading up to the recession. When the housing market tanked, Fannie and Freddie losses piled up. The government took control of the firms in 2008 to keep them solvent.
The guarantee fees were due to rise again. But Watt delayed that move when he joined FHFA, saying he needed to take a closer look at the issue. When these fees rise, they’re typically passed onto borrowers in the form of higher mortgage rates. For now, that might not matter much because rates are low. But that may not be the case in another year or two.
Mark Zandi, chief economist at Moody’s Analytics, said that if the guarantee fees were to rise half a percentage point, that would cut home sales by roughly 250,000 units in a year and reduce housing construction by close to 100,000 units because the higher rates would shut out some consumers.