It all started late last year when both Fannie Mae and Freddie Mac announced a new loan standard for “declining markets.” From now on, said the nation’s largest mortgage buyers, if a local market is “declining” then they reserve the right to reduce the maximum loan-to-value (LTV) ratio for any loan they purchase by 5 percent.
Under the new policy if you bought a $500,000 home in a “declining market” and under the old standards and could purchase with 5 percent down, you would now need 10 percent up front. Your LTV would go from 95 percent to 90 percent. In other words, the down payment requirement increased from 5 percent to 10 percent.
At first this new and tougher policy seems to make a lot of sense. If you have a community where values are falling then a mortgage buyer would be foolish to ignore marketplace trends.
No less important, given that Fannie Mae and Freddie Mac together purchase a majority of U.S. mortgages it follows that their standards powerfully impact the availability of local home loans. Unfortunately, what’s good for mortgage buyers may not be so good for those who wish to finance or refinance a home. Even worse, it may turn out that the new “declining” market rules also create unintended — and potentially unpleasant — consequences for Fannie Mae, Freddie Mac and other mortgage-owning giants such as insurance companies and pension funds.
More Down Needed
A five-percent down payment increase does not seem to be an overly-large number, especially when you consider that the general definition of a “conventional” mortgage has traditionally been 30-year financing with 20 percent down.
In practice, the need to accumulate 20 percent down plus closing costs long ago disappeared from the marketplace. FHA borrowers can typically purchase with about 3 percent down, VA borrowers can buy with nothing up front and loans backed by private mortgage insurance have routinely been available with 5 percent down. Figures from the National Association of Realtors show that in 2007 “the typical first-time buyer purchased a home costing $165,000 and plans to stay in that home for seven years. The median down payment by first-time buyers was 2 percent, but 45 percent purchased with no money down — the same as in 2006.”
Among existing buyers, said NAR, “repeat buyers made a median down payment of 16 percent, the same as in 2006, but 10 percent paid cash for their property. Of those making down payments, 60 percent used equity from their previous home.”
In other words, if you raise the effective down payment requirement from 2 percent to 5 percent then many buyers, especially first-time purchasers, will be washed out of the market.
If you eliminate large numbers of first-time buyers you also remove many repeat buyers from the marketplace. Why? Because before they can move up or just move, repeat buyers need to sell their homes to someone. Since first-time buyers represent almost 40 percent of the marketplace, by removing large numbers of rookie purchasers you also reduce housing demand, especially entry-level homes.
Sticks, Stones & Names
The mere fact that some areas have been defined as “declining” will not thrill many buyers. If you had a choice would you buy a home in a “declining” market or one that’s up-and-coming? Would you be likely to pay full-price in a falling market or something less?
“The issue of labels is important,” says James J. Saccacio, chief executive officer at RealtyTrac.com, the nation’s largest source of foreclosure properties. “Merely saying that an area is ‘declining’ may well impact local home prices and thus result in the very ‘decline’ that the term predicts. Like the chicken and the egg, it’s tough to know which comes first with ‘declining’ markets, the label or the local pricing trend.”
Where Are “Declining” Markets
Fannie Mac says there are several sources which can be used to track local home pricing trends, including the S&P/Case-Shiller Home Price indices, data from the Office of Federal Housing Enterprise Oversight (OFHEO) Index and quarterly state and metro statistics from NAR.
The concern with such reports is that a metro region, state or ZIP code can encompass a large geographic area. Jacksonville, as one example, includes 874.3 square miles, everything from beach-front condos to rural horse farms. If you label an entire area as “declining” that may not be the case for individual neighborhoods or communities, properties in a certain price bracket or individual properties which for one reason or another are highly-desirable. In effect, broad labels can unfairly impact local submarkets which are otherwise strong.
Fannie Mae and Freddie Mac buy loans from local lenders, package them and create securities backed by such loans which are sold to investors on Wall Street. The money received from Fannie Mae, Freddie Mac and other “secondary lenders” is then used by local lenders to create more loans, thus re-starting the cycle.
The linchpin of this system is the belief that each and every loan has been properly underwritten and is secured by property with sufficient value to cover the debt in the event there must be a foreclosure.
However, if Fannie Mae and Freddie Mac are now saying that values in thousands of local communities are in decline, then one has to ask about older loans: Does it not follow that the underlying worth of loans secured by properties in “declining” markets and held in portfolio should also be reduced?
This could be a huge issue for mortgage holders. For instance, in February, Fannie Mae had a loan portfolio valued at $712.1 billion while Freddie Mac’s portfolio was worth $687.6 billion at the end of March. Knock off 1 percent from just these two portfolios and we’re talking about a decline of more than $13 billion.
You can understand the intent of Fannie Mae and Freddie Mac in creating their “declining” market rules; there’s certainly logic to them. That said, will we now have investors and regulators question the worth of massive loan portfolios? After all, if Fannie Mae and Freddie Mac on the basis of broad geographic data say millions of local homes are now worth less than before is the same not true of the securities backed by millions of existing mortgages?
No doubt the same questions have begun to creep up with both Fannie Mae and Freddie Mac. What is the result? On May 16th, Fannie Mae announced a new policy — “declining” markets are out and marketplace equality is in.
Starting June 1st, Fannie Mae will accept up to 97 percent loan-to-value ratios for conventional, conforming mortgages processed through its automated underwriting system, and 95 percent loan-to-value ratios for loans that use other underwriting technologies.
“The new national down payment policy,” said Fannie Mae, “will supersede the policy the company adopted in December 2007 that required higher down payments in markets where home prices are declining.”
“We are today announcing that we will be equalizing the down payment requirements for borrowers in all parts of the country, regardless of local market conditions,” said Marianne Sullivan, Fannie Mae’s Senior Vice President, Single-Family Credit Policy and Risk Management. “This new down payment policy reinforces our goal to support successful home-owning, not just home-buying, as we seek to bring liquidity to all communities and help the housing market recover.”
Peter G. Miller is the author of the Common-Sense Mortgage and is syndicated in more than 100 newspapers.