Freddie Mac has announced that it will cease buying sub-prime mortgages that have a high likelihood of excessive payment shock and possible foreclosure.
First, Freddie Mac will only buy sub-prime adjustable-rate mortgages (ARMs) - and mortgage-related securities backed by these sub-prime loans - that qualify borrowers at the fully indexed and fully amortizing rate. The goal is to protect future borrowers from the payment shock that could occur when their ARMs increase.
Second, the company will limit the use of low-documentation underwriting for these types of mortgages to help ensure that future borrowers have the income necessary to afford their homes. There will be a reasonableness standard for stated incomes.
Freddie Mac will implement the new investment requirements for mortgages originated on or after Saturday, Sept. 1 to avoid market disruptions.
"Freddie Mac has long played a leading role in combating predatory lending and putting families into homes they can afford and keep," said Richard F. Syron, chairman and CEO of Freddie Mac. "The steps we are taking today will provide more protection to consumers and enhance the level of underwriting standards in the market."
John M. Robbins, CMB, chairman of the Mortgage Bankers Association, disagreed with Freddie Mac's decision. According to Robbins, Freddie Mac's revised standards " ... will limit the product options and the access to credit for those individuals most in need, many of whom are first-time, undeserved or minority homebuyers. The mortgage products that these new standards target are important financial instruments, crucial to helping borrowers get into homes and repair their credit. Regulation that further limits consumer choice is unwarranted."
In addition, Freddie Mac will require that loans be underwritten to include taxes and insurance and will strongly recommend that the sub-prime industry collects escrows for taxes and insurance, as is the norm in the prime sector. Because the maintenance of escrow accounts requires significant infrastructure and is not widely used in the sub-prime sector, Freddie Mac did not believe it was practical to unilaterally mandate it as a purchase requirement at the time of the announcement.
"Escrowing for taxes and insurance clearly provides an added layer of consumer protection," Syron said. "It is our hope that this universal practice in prime lending today becomes the universal practice in sub-prime lending tomorrow."
For more information, visit www.freddiemac.com.