Fannie’s gift for the holidays: stricter lending guidelines

This article details how the new lending guidelines from Fannie Mae, which become effective on December 13^th, 2010, will affect the 2.5 million underwater California homeowners who hope to re-enter the real estate market as homebuyers after foreclosure.

Fannie’s new rules

Just in time for the holidays, Fannie Mae (Fannie) is presenting the gift of new lending guidelines to homebuyers shopping for loans that conform to Fannie’s standards. It seems that some, however, will be getting little more than a lump of coal. [For Fannie Mae’s full report on Fannie’s new lending requirement, see the Fannie Announcement SEL-2010-13.]

Effective December 13^th, the government sponsored enterprise (GSE) will be easing up on one key lending regulation. Buyers of single family primary residences will be permitted to apply gift and grant money to the 5% minimum down payment required by Fannie. Previously, only homebuyers who put 20% down were allowed to use gift and grant money to fund their down payment.

Not all of Fannie’s new lending guidelines come adorned with a ribbon and bow. The GSE Grinch is substantially tightening debt-to-income (DTI) ratio standards for those seeking conventional mortgages. Buyers who wish to obtain a Fannie-backed loan will only be allowed a maximum DTI of 45% compared to 55% under previous guidelines. This ratio covers all installment debts owed by the homebuyer and is distinct from the DTI of 31% used to set the maximum loan amount.

Additionally, the revolving debt of future homeowners will come under greater scrutiny. Where Fannie previously overlooked isolated instances of missed payments on outstanding debt, now it will apply 5% to the DTI of those buyers who have missed even a single payment.

Those who are nearing the end of their mortgage loan term — with ten or fewer payments left — will have the remaining balance on their loan included in their DTI, making it more difficult for buyers looking to trade-up or relocate for their retirement. [For more information on the effect shifting demographics have on the California real estate market, see the November 2010 first tuesday article, The demographics forging California’s real estate market: a study of forthcoming trends and opportunities Part I and Part II.]

Homebuyers who have recently gone through a foreclosure will be hit hardest by Fannie’s new regulations. Prior to December 13^th, 2010, individuals with a foreclosure on their record were barred from obtaining a conforming loan for four years, unless they made a 20% or greater downpayment. Under new regulations, borrowers with a foreclosure on their record must wait seven years before qualifying for a conforming loan. This is the government’s kind message to individuals considering a strategic default to get rid of the massive excess debt they have on their home

Fannie Mae currently guarantees approximately 28% of all loans made in the residential mortgage market. As standards toughen, the GSE giant’s market share may decrease as borrowers shop for more attainable, non-conforming (to Fannie Mae) loans.

From one prison to another

One of the greatest lessons we have learned from the Great Recession is increased regulations are necessary to subdue the money-making machine and create economic trends that do not contribute to a raging bull market and ensuing bubble, which always bursts. Although government agencies such as Fannie Mae and the Federal Reserve Bank (the Fed) are working hard to maintain a stable real estate market environment, a consistent vision shared among the varying governmental agencies is lacking. Unfortunately for homeowners who have recently freed themselves from the prison of their underwater homes, this governmental miscommunication is placing them in a modern version of the debtor’s prison.

The GSE twins — Fannie Mae and Freddie Mac — have led the charge toward more responsible lending practices since they were brought under government control in 2008. Increased regulations and more conservative lending have led to a slow but steady recovery – a good thing for the real estate market in the long-term. In general, the concept of a conforming loan has proven effective in shaping sustainable growth in the mortgage lending market. [For more information on GSE regulations, see the October 2010 first tuesday article, The truth is in the numbers: government sponsored entities acquire fewer risky loans.]

However, there comes a time when reason makes a monster of itself and maneuvers made in the interest of sustainability stop making sense. The Fed is pumping cash into the lending market in order to encourage banks to be more liberal with their funds and Fannie Mae, which is just another arm of the government’s regulatory octopus, is taking actions to impede the circulation of these newly minted funds. [For more information on the Fed’s efforts to stimulate the economy, see the October 2010 first tuesday article, The Fed purchases treasuries, fends off deflation.]

The strategic defaulter needs another home

Perhaps a stronger stance on DTIs is prudent — as we move forward with recovery, it is imperative that lenders ensure borrowers are capable of paying back their loans. But there is simply no reasonable argument for why Fannie Mae should increase the time homebuyers need to wait after foreclosure before they may qualify for a conforming loan.  It is purely punitive and heinous in light of congress’ refusal to grant bankruptcy relief to insolvent, underwater homeowners who badly want to save their home, and it is contrary to the government’s housing policy of increasing levels of homeownership.

The new waiting period is now seven years from the date of trustee’s sale, but only two if you are declared bankrupt — essentially this means every homebuyer who was sold a liar loan or snared by sub-prime lending practices during the profligacy of the Millennium Boom will have to suffer through a longer penance period before they can grab the cheap cash the Fed is trying so desperately to get into their hands so they may once again become sustainable homeowners.

Considering the increasing numbers of disenchanted homeowners with loan-to-value ratios (LTVs) over 150% who are opting for strategic default (read: homeowners who are capable of paying their mortgage but unwilling to continue throwing good money away on a grossly devalued home), many buyers with a foreclosure on their record may otherwise be fully capable of qualifying for a conforming loan. [For more information on LTVs and strategic default, see the September 2010 first tuesday article, The LTV tipping point: when negative equity owners strategically default.]

On the bright side, the millions of people who might have tied-up their money in a down payment for a Fannie-backed purchase-assist home loan will be able to buy more gifts for their friends and family this holiday season, which will keep the nation on the recovery track, but do little for our California Multiple Listing Service (MLS) brokers and agents.