Image via WikipediaFundamental changes are probably ahead for the American mortgage system as the federal government pushes to unwind its unprecedented involvement in the housing market. These changes could significantly raise the down payments demanded by lenders, curtail the availability of long-term mortgages with fixed interest rates, and increase the cost of borrowing in general. The government’s effort to scale back its role in housing could show up in small ways soon. In April, the Federal Housing Administration plans to raise the annual premium it charges borrowers by a quarter of a percentage point. In October, the maximum size of loans that the federal government backs is scheduled to drop to $625,500 from $729,750. The most dramatic proposal — eliminating mortgage financiers Fannie Mae and Freddie Mac — could take five to seven years.
The thinking is that the government cannot sustain its role in the housing finance system. Federally backed loans make up an outsize share of home purchases — about 90 percent — through Fannie, Freddie and the FHA. Taxpayers have kicked in more than $130 billion to cover Fannie and Freddie losses during the housing crisis, and they could be on the hook for more if the FHA depletes its cash reserves , which are already lower than the level required by law. All three institutions guarantee that payments will be made to mortgage investors, even when loans go bad. Those guarantees helped keep the housing market from coming to a standstill during the darkest days of the economic crisis.
“But the government is taking on a lot of credit risk,” said Mark Zandi, chief economist at Moody’s Analytics. “So if loans go bad, it’s on the taxpayer. Everyone would find it preferable if the private sector were to take more of the risk.”
Loan Limits to Decrease
To that end, the federal government is eager to tackle the “jumbo” loan limits. In the District and most of its neighboring counties, a temporary federal policy allows the government to back mortgages up to $729,750. Such loans typically carry a lower interest rate than those without government backing, in part because the federal guarantee makes them a safer bet for investors.
“Investors are willing to accept a lower return if their investment is less risky,” said Keith Gumbinger, a vice president at HSH Associates. The Obama administration has supported allowing the maximum loan limit to drop to $625,500 starting Oct. 1 , and Congress is expected to back that move. ( Loan limits may be lowered even further for FHA-insured loans, federal officials said, though no details are available.)
Down Payments and Loan Fees to Increase
Standards are not likely to ease on the down payment front. Borrowers looking to take out FHA loans — the mortgage of choice in recent years for cash-strapped borrowers — could see the minimum down payment requirements rise from 3.5 percent, the administration said in a report to Congress last month. Fannie Mae and Freddie Mac should gradually raise their minimum to 10 percent down, the administration suggested.
Elimination of the 30-Year Fixed-Rate Mortgage
Much further down the line, if Fannie and Freddie are dismantled, the future of the popular 30-year fixed-rate mortgage comes into play. The United State is one of the few countries where most of the mortgages are prepayable, 30-year fixed-rate loans. That means that lenders bear the risk of financing a mortgage that borrowers can then refinance without penalty if rates go down.
With Fannie and Freddie buying the loans, lenders are off the hook if the loans default. They also do not have to worry about a sharp rise in rates during the life of the loan. “The interest rate risk is phenomenal,” Cecala said. “If [lenders] charge 5 percent interest and then the rates shoot up to 10 percent for a 30-year [loan], they are losing money on every one of the loans that they held at 5 percent.”
Other moves are also geared toward raising down payments for certain types of loans. A financial regulatory overhaul enacted last year requires lenders to retain at least a 5 percent stake in the loans they sell to investors. The law carved out an exception for FHA-backed mortgages — considered relatively safe — and it directed regulators to decide by late April if other types of mortgages also should be exempt.
The thinking is that the government cannot sustain its role in the housing finance system. Federally backed loans make up an outsize share of home purchases — about 90 percent — through Fannie, Freddie and the FHA. Taxpayers have kicked in more than $130 billion to cover Fannie and Freddie losses during the housing crisis, and they could be on the hook for more if the FHA depletes its cash reserves , which are already lower than the level required by law. All three institutions guarantee that payments will be made to mortgage investors, even when loans go bad. Those guarantees helped keep the housing market from coming to a standstill during the darkest days of the economic crisis.
“But the government is taking on a lot of credit risk,” said Mark Zandi, chief economist at Moody’s Analytics. “So if loans go bad, it’s on the taxpayer. Everyone would find it preferable if the private sector were to take more of the risk.”
Loan Limits to Decrease
To that end, the federal government is eager to tackle the “jumbo” loan limits. In the District and most of its neighboring counties, a temporary federal policy allows the government to back mortgages up to $729,750. Such loans typically carry a lower interest rate than those without government backing, in part because the federal guarantee makes them a safer bet for investors.
“Investors are willing to accept a lower return if their investment is less risky,” said Keith Gumbinger, a vice president at HSH Associates. The Obama administration has supported allowing the maximum loan limit to drop to $625,500 starting Oct. 1 , and Congress is expected to back that move. ( Loan limits may be lowered even further for FHA-insured loans, federal officials said, though no details are available.)
Down Payments and Loan Fees to Increase
Standards are not likely to ease on the down payment front. Borrowers looking to take out FHA loans — the mortgage of choice in recent years for cash-strapped borrowers — could see the minimum down payment requirements rise from 3.5 percent, the administration said in a report to Congress last month. Fannie Mae and Freddie Mac should gradually raise their minimum to 10 percent down, the administration suggested.
Elimination of the 30-Year Fixed-Rate Mortgage
Much further down the line, if Fannie and Freddie are dismantled, the future of the popular 30-year fixed-rate mortgage comes into play. The United State is one of the few countries where most of the mortgages are prepayable, 30-year fixed-rate loans. That means that lenders bear the risk of financing a mortgage that borrowers can then refinance without penalty if rates go down.
With Fannie and Freddie buying the loans, lenders are off the hook if the loans default. They also do not have to worry about a sharp rise in rates during the life of the loan. “The interest rate risk is phenomenal,” Cecala said. “If [lenders] charge 5 percent interest and then the rates shoot up to 10 percent for a 30-year [loan], they are losing money on every one of the loans that they held at 5 percent.”
Other moves are also geared toward raising down payments for certain types of loans. A financial regulatory overhaul enacted last year requires lenders to retain at least a 5 percent stake in the loans they sell to investors. The law carved out an exception for FHA-backed mortgages — considered relatively safe — and it directed regulators to decide by late April if other types of mortgages also should be exempt.
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