Mel Watt's decision to back mortgages with a 3% down payment promises to have the same effect on homeownership as his negotiations with lenders.
Watt, the regulator of Fannie Mae and Freddie Mac, has been trying for almost a year to get banks to lend to worthy borrowers who have been denied credit. After Watt said that the two companies would back mortgages with 3% down, Fannie Mae yesterday announced that the loans will be confined mostly to first-time buyers. Freddie Mac's will be restricted primarily to borrowers with modest incomes.
Because banks require high credit scores for low-down-payment loans, very few will qualify, said Sam Khater, deputy chief economist at mortgage data firm CoreLogic LLC.
"If anything, the new product might be so limited that it doesn't provide as much assistance as it could," said Julia Gordon, who directs housing finance and policy at the Center for American Progress, which has ties to the Democratic Party.
Fannie Mae and Freddie Mac, which buy more than half of new home loans and package them into bonds, currently allow down payments as low as 5%. Starting on Dec. 13, Fannie Mae will back loans with a 3% deposit and permit borrowers who refinance to reduce their equity to 3% to cover closing costs, the company said in a statement. Freddie Mac will begin in March to buy 3% down mortgages to borrowers with below-median earnings. If they are also first-time buyers, they must get housing counseling to qualify.
Watt is trying to ease credit to deserving borrowers while stopping short of the lax lending standards that sparked the housing collapse in 2008.
"These underwriting guidelines provide a responsible approach to improving access to credit while ensuring safe and sound lending practices," Watt, the head of the Federal Housing Finance Agency, said in a statement yesterday.
Watt has also been negotiating with banks and adjusting rules for most of 2014 to resolve the biggest road block to home lending — who pays for loans backed by Fannie Mae and Freddie Mac that go bad. Lenders have stiffened mortgage requirements above what the two government-controlled companies require — so-called overlays — to reduce the possibility of defaults and loan losses.
Watt last month announced that lenders won't be asked to repurchase loans with inaccurate data or misrepresentations of buyers' qualifications unless the flaws are significant and apply to multiple loans, or unless there’s clear evidence of fraud.
Lenders have said that these rule changes won't have a significant impact on lending. Brian Moynihan, the chief executive officer of Bank of America Corp., said his company won't be extending credit to a broader range of borrowers.
"You won't see us start to expand our criteria much past what we've done today," Moynihan said Nov. 12 at a New York investor conference. "I don't think there's a big incentive for us to start to try to create more mortgage availability where the customers are susceptible to default."
Avid Modjtabai, head of consumer leading at Wells Fargo & Co., said in November that the bank has been removing some of its mortgage overlays since the beginning of the year.
"Months ago we started looking at overlays because we were seeing that there were impacted customers," Modjtabai said.
This year, easing the restrictions has boosted Wells Fargo’s mortgage volume by less than 10%, said Franklin Codel, who oversees home loan origination at the bank. The FHFA rule changes and the further reduction of overlays may increase Wells Fargo's mortgage lending by slightly more than that in 2015, he said.
Officials at Fannie Mae, Freddie Mac and FHFA said on a conference call with reporters yesterday that they could not specify how many first-time and low-income borrowers might be eligible for the new programs.
First-time buyers have comprised about 40% of all home sales on average since 1981. That percentage fell to 33 percent this year, the lowest since 1987, according to a survey by the National Association of Realtors.
While 3% down loans will appeal to buyers who haven't saved enough money for a larger deposit, borrowers will probably still need to have a high FICO credit score. Applicants approved for mortgages to purchase homes had an average score of 755 in August, according to Ellie Mae, a mortgage technology company.
That's well above the average score for Americans, which was 692 in April.
A study by the Urban Institute Housing Finance Policy Center found that when Fannie Mae previously allowed loans with down payments below 5%, these mortgages accounted for less than 1% of its business. The loans only made sense for borrowers with relatively strong credit scores, because Fannie Mae charged high prices for riskier borrowers.
Codel said Wells Fargo would be carefully scrutinizing borrowers who opt to put only 3% down.
"The customers are going to be fully underwritten," he said. "We're going to be looking hard for sustainability and ability to repay when you don’t have as much equity in the product."
Khater of CoreLogic said the 3% programs probably won't help Americans whose credit scores are currently keeping them out of the market. The effect will be fairly modest and incremental because borrowers will need to have strong qualifications to offset their small down payments, he said.
The programs will reduce costs for borrowers whose only option has been a loan backed by the Federal Housing Administration. The FHA, a government mortgage insurer, backs loans with down payments as low as 3.5%. The agency has been raising its up-front fees and annual premiums in an effort to shore up its finances, making it an expensive option for the entry-level buyers it serves.
"The most important thing about this is that it gives consumers choice" between mortgages backed by Fannie Mae and Freddie Mac and those backed by the FHA, said Mark Goldhaber, a principal at North Carolina-based Goldhaber Policy Services LLC.
Expanding mortgages to homeowners whose biggest challenge is producing a 20% down payment is a valuable step on the way to easing lending, said Jim Parrott, a senior fellow at the Urban Institute and former housing-policy adviser to President Barack Obama.
"There are many, many small problems that are making access to credit difficult," Parrott said. "There are lots of relatively small- to medium-sized steps that in the aggregate will have a big effect."
