You May Soon Need Less Of A Down-Payment To Buy A Home

One of the biggest hurdle’s to buying a home is coming up with a down-payment. In order to get a mortgage backed by Fannie Mae or Freddie Mac, you generally need to come up with at least 5% of the total cost. But the federal regulator overseeing Fannie and Freddie says it has reached a deal that would lower that minimum back down to 3% for some borrowers.

In prepared remarks for a speech at the Mortgage Bankers Association Annual Convention in Las Vegas on Monday, Federal Housing Finance Agency Director Melvin Watt said his agency had reached an agreement in principle with Fannie and Freddie that would develop “sensible and responsible” guidelines for mortgage borrowers with as little as 3% to use as a down-payment.

Fannie and Freddie buy mortgages from lenders and then bundle them up, turn them into securities and sell those securities off to investors.

During the heyday of the housing bubble, a number of lenders misled Fannie and Freddie into believing they were buying mortgages that were not high-risk. However, many loans were given to people who could never have afforded to repay and so the market soon collapsed, dragging the entire economy into a sinkhole with it.

Fannie and Freddie were eventually bailed out by the federal government and subsequently forced several lenders to buy back billions of dollars in worthless mortgages.

Since then, lenders have been wary of issuing mortgages to applicants with subprime credit or little money to use for a down-payment. The banks were concerned that they could once again be compelled to buy back these loans if they turned sour after a few years, even if the lender had done its due diligence in reviewing the loan application.

While the details are still to be fully revealed, the deal between the FHFA and Fannie and Freddie is intended to clarify exactly under what conditions a lender could be forced to buy back a bad loan.

For example, for Fannie or Freddie to claim that a lender has a pattern of misrepresenting the quality of its loans, it would have to show that a certain number of the loans were bad or inaccurate.

There will also be what Watt dubbed a “significance” requirement for demonstrating that a loan should be repurchased.

According to Watt, the significance test would require that Fannie or Freddie demonstrate “that the loan would have been ineligible for purchase initially if the loan information had been accurately reported.”

So if a lender makes a loan that goes bad because the borrower lost her job and her kids got sick with some expensive disease, Fannie or Freddie is stuck with that loan. But if the lender approves a loan knowing, for example, that the borrower is a freelancer with spotty consulting work that may dry up, Fannie or Freddie might have an argument if she defaults.

“We have started to move mortgage finance back to a responsible state of normalcy,” explained Watt, “one that encourages responsible lending to creditworthy borrowers while maintaining safety and soundness.”

Of course, even if Fannie and Freddie agree to a framework that once again allows them to purchase loans made to borrowers with lower down-payments, it doesn’t mean that the banks have to make those loans.

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