Fannie Tightens Lending Standards By Nick Timiraos Wall Street Journal 04-30-2010

Fannie Tightens Lending Standards
By Nick Timiraos
The Wall Street Journal
April 30, 2010

Fannie Mae on Friday said it will tighten lending standards on adjustable-rate mortgages and "interest-only" loans that helped fuel the housing bubble and have led to a disproportionate share of losses for the mortgage-finance giant.

The changes, which will take effect in September, will require lenders to qualify borrowers based on whether or not they can afford potentially higher payments once adjustable-rate loans reset, and will require much more stringent criteria for interest-only borrowers.

During the housing boom, borrowers increasingly used adjustable-rate mortgages with low initial rates to buy bigger homes and banked on ever-rising values to refinance before payments rose higher. When prices stopped rising, more borrowers weren't able to sell or refinance to avoid higher payments. That sent defaults soaring.

Fannie and its smaller rival, Freddie Mac, were taken over by the government through a legal process known as conservatorship in September 2008 as rising losses threatened to wipe out thin capital reserves. So far, Fannie and Freddie have required more than $126 billion in taxpayer infusions, a number that is likely to grow.

Interest-only mortgages, which allow borrowers to defer principal payments for the first five or 10 years, accounted for just 6.6% of Fannie's total loan book at the end of 2009 but were responsible for one third of all losses in the fourth quarter. Nearly one in five interest-only loans were 90 days or more past due at year end, and one-quarter of the loans had loan-to-value ratios that exceeded 125%.

Freddie Mac said earlier this year that it would stop buying interest-only loans in September. Fannie said it will continue to offer such loans, but it will require borrowers to have credit scores of at least 720 and 30% equity. Borrowers must also have at least two years worth of cash reserves remaining after closing.

For adjustable-rate mortgages that reset within their first five years, lenders will have to qualify borrowers under higher payment levels, using the greater of either the current interest rate plus two percentage points, or the current interest rate plus the extra margin charged by the lender.

"Our goal is to make sure consumers can sustain their mortgages and remain in their homes over the long term, while helping our lender partners offer a range of mortgage products for qualified borrowers," said Marianne Sullivan, a senior Fannie Mae risk-management official.

Adjustable-rate mortgages accounted for one in six loans made by Fannie in 2006, but just 3% of such loans made last year. Interest-only loans, which accounted for 15% of all loans made by Fannie in 2007, represented just 1% of total lending volume in 2009.