In late 2013, Fannie Mae increased the minimum down payment from 3% to 5%. Now, they are ready to come back to the original terms, but many analysts are still wondering whether this is a prudent move.
Fannie Mae was profitable in this year’s third quarter, with $3.9 billion net income and $6 billion net revenue, although their earnings dropped by 55% compared to the third quarter of 2013. The improvements made to their key operations suggest that the agency can offer mortgages with lower down payments, with no safety risks. Why would they do that?
1. Easing lending terms
The agency needs more loans to fulfill their mission, which is making home ownership accessible to more people. This cannot be accomplished without the participation of the lenders. In order to convince the latter, besides lowering down payments, they are willing to assume some reasonable risks themselves.
Lowering down payments may not seem such a spectacular move, but it can make a difference for first-time buyers, because it is much easier for them to come up with 3% of their dream home’s value than it is with 5%.
2. Solving mortgage insurance problems
One of the reasons why FHFA, the regulator of Fannie Mae and Freddie Mac were reluctant to a lower down payment was due to some private mortgage insurers who failed to pay their claims. To solve this problem, they have been working to develop and implement new mortgage insurers capital standards.
3. Risk sharing securities
Like Freddie Mac, Fannie Mae have created new securities, meant to share some of the risks associated to mortgage loans. Their ability to handle these securities depends on the interest of the investors. While the interest of the investors is still low, using these deals to discharge risk is not feasible. Incipient forms of risk sharing were used even before the crisis of the mortgage-lending sector, but, now, they are sold consistently on the secondary market.
4. Home prices
The depreciation of home prices is the main concern governing the loan industry. Since prices in most areas have dropped significantly, borrowers can end up with a property that is worth less than the loan balance, especially when the down payment is low. This could encourage borrowers to stop paying for something that is worth less than what they owe.
However, home equity loss does not cause as many foreclosures as job loss and steep medical bills. If Fannie Mae layered multiple risk factors in their loans, this could easily lead to foreclosure. Moreover, they continue to have risk-based loan pricing for that reason.
5. Appraisal integrity
Integrity studies have shown that material errors still show up in appraisals. Fannie Mae uses new technologies meant to standardize appraisal data. They require the lenders to submit their evaluation reports for analysis electronically. Property appraisals continue to rely heavily on the opinions of the appraisers, but, with the new measures in place, they’re beginning to be backed by more objective data.
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