Fannie Mae announces improved standards for buyers

Beginning October 20, 2012, Fannie Mae will tighten standards on the notes they purchase, meaning lenders will have to increase homebuyer qualification standards to ensure their ability to sell these notes to Fannie. The changes include higher Fair Isaac Corporation (FICO) scores for adjustable rate mortgages (ARMs), and more documentation to verify income.

Changes to ARM transactions include:

• an increase in the minimum FICO score from 620 to 640;
• the maximum loan-to-value ratio (LTV) for one-unit, principal residence, purchase and limited cash-out refinances will be 90% for both desktop underwriting (DU) and manually underwritten loans(reduced from 95% and 97%, respectively); and
• the majority of ARM transactions will have maximum LTVs of 10 percentage points less than previously, not falling below 60%.

The buyer debt-to-income ratio (DTI) maximum will be 36%, unless the loan meets credit score and reserve requirements (found unchanged in Fannie’s Eligibility Matrix), then it may be as high as 45%.

Changes to loans receiving DU are:

• condo projects evaluated under the Limited Review process will have a reduced maximum LTV of 80%;
• exterior-only property inspection appraisals will no longer be permitted;
• income documentation requirements will be stricter;
• minimum reserve requirements for two- to four-unit principal residence properties will increase.

The maximum allowable deductible for flood insurance of first- and second-lien mortgages will be $5,000, unless a higher maximum is allowed by state law.

The California Housing Loan Insurance Fund (CaHLIF) has not been an eligible insurer of loans delivered to Fannie Mae since 2010. However, certain RefiPlus, modified or refinanced balloon loans will be able to be delivered to Fannie Mae if continuation of coverage is effected through modification of the existing mortgage insurance certificate by CaHLIF.

Critics have warned these changes will make it harder for buyers to acquire loans, and threaten the unstable housing market recovery.

first tuesday insight

Will Fannie’s measures slow the recovery as its critics suggest? Possibly. However, is it bad to have a slow and steady recovery? No!

Fannie could throw all its regulations out the window and the recovery would likely take off, but it would be a bubble recovery, sure to bust as soon as unqualified buyers begin defaulting.

First, no one ought to finance their home with an ARM if their credit score is 620! (For reference, Fannie Mae and Freddie Mac’s average acceptable FICO score is around 760 – far above the new ARMs minimum of 640). ARM loans are generally a very bad idea unless the buyer is a pro (read: speculator), and even then, with caution.

The exponential increase of ARM transactions in the 2000s was a key ingredient in causing the recession. Along those lines, a 90% LTV on ARM loans is well within reason – the more initial equity, or skin in the game, a buyer has in the home, the more likely he is to continue paying the loan once its rate begins increasing. Speculators – those most likely to use ARMs – are likely to have as little skin in the game as possible, so as to keep cash on hand for other investments— not a recommended strategy for owner occupants or those desirous of a stable housing market.

The changes to DU are fine, as well. If a buyer does not meet the requirements for DU, they are not automatically disqualified, but they will be referred for manual underwriting. Manual underwriting is actually more helpful than automated DU, since lenders are able to make informed lending decisions, as buyers are inspected more thoroughly. Still, it takes longer, thus lenders logically prefer buyers who will pass inspection under DU.

These regulations are more likely to aid the recovery than disable it. Even if it means lenders approve fewer buyers, it sets a precedent for stricter lending, which will strengthen the bond market and potentially provide some shock absorption for the bumpy plateau recovery.

Re: SEL-2012-07: Selling Guide and Other Updates from Fannie Mae and Fannie Mae Tightens Mortgage Standards for Some Home Buyers from the Washington Post