Proposals to lower the minimum down-payment on Fannie Mae and Freddie Mac-backed mortgages at the same time as reducing banks’ exposure to put-back risk may help accelerate the planned modest loosening in mortgage credit conditions.
But, notes Capital Economics in a client note, the changes will mean Fannie Mae and Freddie Mac take on substantially more credit risk, which will do nothing for the long- term aim of reducing their role in the provision of mortgage credit.
“There were few specifics in FHFA Director Mel Watt’s speech to the Mortgage Bankers Association last week, but the most eye-catching proposal was to lower down-payments on Fannie Mae and Freddie Mac-backed loans to between 3%-5%. Current requirements vary, but successful applications normally need down-payments of 20%, which is a constraint on lending volumes,” says Paul Diggle, property economist for Capital Economics.
He notes that borrowers can already access mortgage credit with a low down-payment through the Federal Housing Administration. But the substantial mortgage insurance premiums attached to these loans are constraining uptake, which would presumably also be the case if Fannie Mae and Freddie Mac charged comparable fees.
“Moreover, a down-payment of 3% can disappear very quickly. House prices have fallen by that much in Chicago, Detroit and Minneapolis in recent months. While the FHFA has said it will be targeting ‘creditworthy but lower-wealth borrowers,’ we are yet to be persuaded that a dramatic reduction in down payments can be achieved without a substantial increase in levels of credit risk,” Diggle says.
He contends that a more sensible proposal is a revision and clarification of the representation and warranty framework that governs when Fannie Mae and Freddie Mac will foist delinquent loans back onto banks. The high prevalence of ‘put-backs’ is a major factor constraining mortgage lending.
“But in addition to some clarification, the latest proposals appear to include a watering-down of the representation and warranty framework. For example, the FHFA intends to set a minimum number of loans that must be identified as not meeting representation and warranty standards before put-backs occur. Nevertheless, purely from the standpoint of boosting short-term housing market activity, these changes are helpful,” Diggle says.
“The bottom line, however, is that these proposals are at odds with the long-term aim of running down the role of Fannie Mae and Freddie Mac in the mortgage market. Recent mortgage reforms are already encouraging lenders to write conforming loans over loans backed by private capital. The new initiative to make conforming loans more attractive through low down-payment requirements and relaxed representation and warranty conditions is only going to make it harder to wean the industry off its reliance on Fannie Mae and Freddie Mac,” he said.