There have been several efforts by the government to help struggling homeowners, and most haven’t accomplished much. Now there’s a new plan to help first-time buyers purchase a property—and it’s already controversial.
Mel Watt, director of the agency that oversees the mortgage-finance giants Fannie Mae (FNMA) and Freddie Mac (FMCC), says the government will soon announce new rules meant to lower the required down payment on home purchases and relax other rules that have left many potential buyers unable to get approved for a mortgage. Watt hasn’t yet spelled out the details, but the changes might allow buyers to score a property with a down payment of as little as 3%.
High standards for mortgages have kept many buyers out of the market and contributed to a lackluster housing recovery. Yet pushing the required down payment as low as 3% could cause some of the same problems that led to a brutal housing bust nearly a decade ago. “It has the potential to increase the risk taxpayers have with regard to guaranteeing those mortgages,” Edward DeMarco, Watt’s predecessor as director of the Federal Housing Finance Agency, tells me in the interview above.
Fannie Mae and Freddie Mac don’t issue mortgages, but instead purchase them from lenders, package them into securities and protect investors who buy those securities against losses—with taxpayers footing the bill if something goes wrong. That system worked for decades and kept ample credit flowing to home buyers, but it foundered in the early 2000s as lenders lowered their standards to the point that nearly anybody could get a mortgage. The two housing agencies bought hundreds of thousands of soon-to-default mortgages that banks mischaracterized as safe, which helped crater the whole financial system and led to the Fannie and Freddie bailouts in 2008.
The FHFA, under DeMarco, was tasked with fixing Fannie and Freddie--which have now become profitable once again. At the same time, a surge in mortgage defaults led to millions of foreclosures and calls for Fannie and Freddie to cut stressed home owners some slack. DeMarco resisted such moves, arguing that his job was to nurse the two agencies back to health, period. When Watt replaced DeMarco late last year, some hoped he’d push programs to forgive certain payments or find other ways to help struggling homeowners.
The promised changes in down-payment requirements are one of Watt’s first major initiatives. DeMarco worries that such a low down payment will leave borrowers too stretched if there’s a job loss, family emergency or other externality that forces a quick sale of the property. ”The selling cost of getting out of a mortgage is 6, 7 or 8 percent,” he says. “So if you haven’t put that money down, you’re effectively underwater and you’re going to lose money on that transaction right then and there.”
The counterargument is that lenders and the housing agencies are playing it too safe right now, with a shortage of the prudent risk-taking that allows capitalism to flourish during normal times. The FHFA plans to address that in another way, by clarifying and perhaps loosening the terms lenders must meet when they sell mortgages to Fannie and Freddie for securitization. That would alleviate a huge new concern of bankers—that they’ll get sued long after the fact by one of the agencies or be forced to buy back loans that seemed safe at the outset but turned out to be troubled for some reason the lender couldn’t control.
Most housing finance experts agree that reforms are needed, if only because Fannie and Freddie are now de facto duopolists controlling the entire market for mortgage securitization. But given the slow pace of action in Washington, it could still be years before Fannie and Freddie evolve into something other than zombie companies in yoke to the government.
Potential home buyers, meanwhile, should benefit as lending standards gradually loosen and the market inches back to normal. DeMarco advises those planning to buy to polish their credit score, keep saving for a down payment and seek out home buying counseling to help understand the many complexities of purchasing a home. As Fannie and Freddie prove, it’s a lot more complicated than it used to be.
Rick Newman’s latest book is Rebounders: How Winners Pivot From Setback To Success. Follow him on Twitter: @rickjnewman.