April 30, 2010

Fannie Mae, the government-backed mortgage giant, announced Friday that it will tighten lending requirements for the interest-only loans and adjustable rate mortgages (ARMs) it backs. To get a Fannie Mae-backed interest-only mortgage, for example, homebuyers will have to make down payments of 30% of the sale price.  For adjustable rate mortgages, Fannie will only buy those underwritten to ensure that borrowers could still afford payments even if their interest rates reset to the higher of either 1) the loan's initial interest rate plus two percentage points or 2) the maximum the interest rate the loan can rise to, known in the industry as the cap rate. For a loan with a beginning rate of 5% and a cap rate of 6%, for example, borrowers would have to demonstrate they could still keep up payments even if the rate rose to 7%. If the cap rate is 8%, borrowers would have to be able to afford an 8% loan.

"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, Senior Vice President of Single Family Credit Policy and Risk Management at Fannie Mae, in a prepared release.

"These policy changes reflect our intention to continue providing liquidity to different market segments by ensuring that support for ARM products remains in appropriate circumstances," Sullivan said.

Fannie does not issue mortgages itself; it buys them from lenders. But few lenders will issue loans these days unless they can sell them to Fannie Mae.  Fannie Mae will also demand that borrowers of interest-only loans have credit scores of at least 720 and sufficient cash cushions to be able to continue mortgage payments and other housing expenses for 24 months.  Meanwhile, Fannie says it will stop funding so-called balloon mortgages. With these, borrowers pay at a rate lower initially than the nominal interest rate on their mortgages. The difference between the two builds up every month and has to be repaid with one huge payment at a specified date. Many borrowers saw those balloons swell to unmanageable proportions and lost their homes when they couldn't afford or refinance the balloon payment.

The new guidelines go into effect after August 31.