Fannie Mae Makes it Tougher to Get ARMs, Interest-Only Mortgages

Fannie Mae has to perform a delicate balancing act as it promotes homeownership and responsible lending.

The government sponsored entities (GSEs) Fannie Mae and Freddie Mac have come under incredible scrutiny over the last several years due to their roles in the financial crisis and the meltdown of the housing market.  The GSEs required more than $120 billion to save them from collapse, a number which is expected to increase as defaults pile up.

Fannie Mae and Freddie Mac buy mortgages from lenders and sell them to investors while guaranteeing them against default. The purpose of the GSEs is to provide liquidity in order to promote lending, and to foster stability in housing markets.

Fannie Mae serves the dual function of promoting wider home ownership while simultaneously managing risk and making a profit for its shareholders.  Juggling these interests can be difficult, as Fannie comes under pressure from politicians and shareholders whose interests are often at odds with one another.  In the early 2000s, Fannie Mae felt pressure to move into the subprime lending market because of its own shrinking market share and the growing popularity of those loan types.  Subprime mortgages, interest-only mortgages, and adjustable rate mortgages (ARMs) were one of the catalysts in the lending implosion.

In response to the criticism and crisis, Fannie Mae is tightening underwriting standards for ARMs and interest only loans.  For ARMs, Fannie Mae will require lenders to take into account a borrower’s ability to make their mortgage payments when rates change.  A seemingly large loophole in the new standards is that they do not take into account the possibility of a large jump in interest rates.  The new rules go into effect in September, and effect ARMs that adjust in five years or less.

Fannie is also going to institute tighter standards for interest only loans. Under these types of loans, borrowers do not make any principal payments for several years into their mortgage.  This enables people to make low mortgage payments initially, but also makes these borrowers more susceptible to default in the event of declining property values.  To get an interest only mortgage through Fannie Mae, a borrower must have a down payment of 30 percent, and enough assets for two months of living expenses.

Freddie Mac has already implemented similar rules regarding ARMs, and has discontinued purchasing interest-only loans.

Marianne Sullivan, senior VP of Single Family Credit Policy was quoted in an AP article as saying, “Our goal is to make sure consumers can sustain their mortgages and remain in their homes over the long term”.

Do you think these new regulations will be effective in promoting more responsible lending?  Let us know in the comments section below.