New Freddie Mac® Rules Affect Borrowers

What’s all the buzz these days about the mortgage industry? The news is filled with stories about the meltdown in the subprime mortgage market and how Freddie Mac®, the company that serves as one of the nation’s largest buyers of home mortgages, is going to start tightening its subprime underwriting standards. What exactly does that mean? And what, if any, impact is it going to have on those shopping for a home?

Well, first of all, it’s important to understand that the new rules are primarily going to affect those looking for a subprime loan. That’s a loan, typically granted at a higher interest rate, to those who don’t qualify for a conventional loan because of their poor credit rating (a FICO score in the lower 600’s or less). The rules are also only going to apply to adjustable rate mortgages (ARMs) -- loans that have a fluctuating interest rate with lower initial payments, as opposed to traditional fixed-rate loans.

Why is Freddie Mac® tightening ARM rules?
It’s all because of fallout from the recent housing boom during which many lenders granted subprime ARMs to those who wouldn’t otherwise qualify to buy a home. Some lenders even offered extra low introductory “teaser” rates that made it easier than ever to be able to afford a mortgage.

So long as interest rates remained low and housing prices kept soaring, the risk to both homeowners and lenders was minimal. But things started changing when the housing market slowed and interest rates started edging up. Many homeowners who’d taken out ARMs with an initial low interest rate found themselves unable to cover the higher monthly payments that kicked in once the low-rate period ended. If their home (and their home equity) had also decreased in value, they may have found that they were no longer qualified to arrange a lower payment by refinancing their mortgage.

To help prevent homeowners from getting into such a situation, where they may end up having to default on their mortgage and face foreclosure, Freddie Mac is going to start requiring borrowers applying for subprime ARMs to qualify at the fully indexed and amortizing rate, including the cost of taxes and insurance. That means those applying will have to qualify not just for the initial monthly payment being offered, but also for the potential maximum monthly payment they could end up having to cover in the future. It’s also going to better verify that borrowers have the necessary income to afford to buy a home by no longer buying loans that don’t require income or asset documentation and restricting “stated income, stated asset” loans to borrowers with income that’s very hard to verify (such as the self-employed).

What should you do if you have an ARM that’s about to reset?
If your ARM is about to reset at a higher rate and you’re worried you won’t be able to afford the higher payments, consider refinancing now. Freddie Mac’s new rules only apply to mortgages that originate on or after September 1, 2007. If you currently have a subprime loan and are concerned you may no longer qualify to refinance under the stricter guidelines, you may be wise to do so now before they go into effect.

How can you buy a home in the future if you have poor credit?
Your best bet is to start taking steps now to improve your credit rating. That means start paying your bills on time and working to pay off other outstanding debt. Not only will you benefit from an improved credit report, but the good news is that by the time you’re ready to buy, you’ll likely also have a wider choice of mortgage products to choose from. Along with tightening lending standards, Freddie Mac is also developing new hybrid ARMs designed to limit payment shock by reducing adjustable rate margins and lengthening both fixed-rate terms and reset periods.

Stricter mortgage rules may not at first appear to be good news for home buyers. But in the long run, Freddie Mac’s new regulations should help to put families in homes they can afford to keep, to stabilize the housing market and to protect consumers from predatory lending practices.