Fannie and Freddie Begin Offering Riskier Loans

Critics warn that lower lending standards could destabilize housing market

December 9, 2014

Housing giants Fannie Mae and Freddie Mac on Monday released the final guidelines for low down payment mortgage loans, reviving a practice that critics say could eventually lead to defaults and another financial crisis.

Fannie and Freddie announced that eligible first-time homebuyers could now obtain mortgage loans with down payments as low as 3 percent. Both entities still purchase a majority of loans in the housing market and remain under government conservatorship after the 2008 crisis.

Fannie and Freddie, known as government-sponsored enterprises (GSEs), said that borrowers would have to clear several hurdles before they could take out the loan. Those include obtaining private mortgage insurance, providing income documentation and verification, and seeking homebuyer education and counseling.

Federal Housing Finance Agency (FHFA) Director Mel Watt said in a statement that the lower lending standards "will enable creditworthy borrowers who can afford a mortgage, but lack the resources to pay a substantial down payment plus closing costs, to get a mortgage with 3 percent down."

"These underwriting guidelines provide a responsible approach to improving access to credit while ensuring safe and sound lending practices," he said.

Peter Wallison, fellow at the American Enterprise Institute (AEI) and former general counsel to the U.S. Treasury Department under President Ronald Reagan, said in an interview that the new loans could eventually inject more risk into the housing market.

Required premiums for mortgage insurance will raise the cost of homes, he argued, making them unaffordable for many buyers. Pressure will then mount to make the mortgages more accessible, and risky.

"When those loans do not really result in any significant numbers in increased low-income loans, they will reduce the underwriting standards further," he said.

"Eventually will be back in a situation a year from now in which many of these loans will look like the loans before the financial crisis," he added.

The low down payment loans could also be a political move to placate Democrats who have long pushed for looser lending standards to aid low-income borrowers, Wallison said.

Fannie and Freddie had mostly ended the practice of low down payment mortgages in recent years, though Fannie accepted some 3 percent loans into late last year.

Wallison said the housing market has stabilized somewhat since 2008 with the issuance of fewer risky mortgages. Risk in the market has increased more slowly, AEI’s International Center on Housing Risk said last week, but there are still too many high and medium-risk loans to ensure a stable market in the long run.

The national homeownership rate was 64 percent in the third quarter, close to its level before the housing bubble of the early 2000s.

Wallison noted that taxpayers will again foot the bill if Fannie and Freddie’s mortgage loans default in large numbers. Treasury provided $188 billion to the GSEs in 2008 to keep them afloat.

"The only reason banks will make these loans is that they can sell them to Fannie and Freddie," he said. "Taxpayers are going to take the risk."