Freddie Mac (NYSE:FRE) today announced that it will cease buying subprime mortgages that have a high likelihood of excessive payment shock and possible foreclosure. The GSE said it will only buy subprime adjustable-rate mortgages — and mortgage-related securities backed by these subprime loans — that qualify borrowers at the fully-indexed and fully-amortizing rate. Freddie also said it will limit the use of low-documentation underwriting for these types of mortgages, in an effort to help ensure that future borrowers have the income necessary to afford their homes. In addition, the GSE said it will strongly recommend that mortgage lenders collect escrow accounts for borrowers’ taxes and insurance payments. In keeping with its statutory responsibility to provide stability to the mortgage market, Freddie Mac will implement the new investment requirements for mortgages originated on or after September 1, 2007, to avoid market disruptions.
To help lenders better serve borrowers with impaired credit, Freddie Mac said it is also developing fixed-rate and hybrid ARM products that will provide lenders with more choices to offer subprime borrowers. For example, in contrast to the payment structures of many of today’s “2/28” ARMs, Freddie Mac’s new hybrid ARMs will limit payment shock by offering reduced adjustable rate margins; longer fixed-rate terms; and longer reset periods. Freddie Mac will require originators to underwrite these products at the fully indexed and amortizing rate. The company plans to commit significant capital to purchasing these loans into its retained portfolio. “Freddie Mac has long played a leading role in combating predatory lending and putting families into homes they can afford and keep,” said Richard F. Syron, chairman and CEO of Freddie Mac. “The steps we are taking today will provide more protection to consumers and enhance the level of underwriting standards in the market.” Freddie Mac’s new requirements cover what are commonly referred to as 2/28 and 3/27 hybrid ARMs, which currently comprise roughly three-quarters of the subprime market. The company also said it will no longer purchase “no documentation” loans and will limit stated income products to borrowers whose incomes derive from hard-to-verify sources. In addition, Freddie Mac will require that loans be underwritten to include taxes and insurance and will strongly recommend that the subprime industry collect escrows for taxes and insurance, as is the norm in the prime sector. “Escrowing for taxes and insurance clearly provides an added layer of consumer protection,” Syron said. “It is our hope that this universal practice in prime lending today becomes the universal practice in subprime lending tomorrow.” For more information, visit http://www.freddiemac.com.