One of the core components of the idea of the "American Dream" has generally been ownership of one's own home. However, the recent announcement that Fannie Mae (NASDAQOTCBB:FNMA) and Freddie Mac (NASDAQOTCBB:FMCC) could be wound down in as soon as five years has led to some speculation on whether or not home ownership will remain attainable and affordable for the younger generations of Americans.
The importance of Fannie and Freddie
Love them or hate them, one thing is for certain: Fannie and Freddie ensure that traditional 30-year mortgages are readily available. They also help to keep interest rates very affordable, as the banks know that they aren't taking much risk, since they are guaranteed to get paid back.
The thought of Fannie and Freddie going away leads some people to believe that mortgages will no longer be obtainable for middle-class homebuyers, but this is simply not the case. Not only will readily accessible financing for first-timers remain, but the end of Fannie and Freddie could in fact be a good thing for home ownership in America and make it easier for first-timers to qualify for a mortgage.
The proposed changes and how they'll reshape the mortgage market
Basically, the biggest impact of the bill that was recently introduced in the Senate is that Fannie and Freddie would be wound down over a period of five years, and would replace it with a government-backed mortgage bond insurance system. Essentially, there would be a bunch of private companies that would continue to do what Fannie and Freddie are doing: ensuring that 30-year mortgages are available and affordable.
Why economists seem to be getting worried is that the new system, in an effort to encourage responsible lending and to protect taxpayers, will require the private lenders to absorb the first 10% of losses before the government insurance kicks in. It also eliminates the mandate that a percentage of mortgages go to lower- and middle-income Americans, which some fear will make homeownership inaccessible.
More lenders means a free mortgage market
The key point to remember here is that these are private lenders that will replace Fannie and Freddie, and plenty of them. Private companies exist for one reason – to make money. Increasing competition for mortgage originations will, if anything, increase the availability of affordable mortgages as these private firms compete for business.
Because some of their own money is at stake, it will create somewhat tight lending standards, but that's nothing new. Ever since the foreclosure epidemic, mortgage standards have been pretty high on a historical basis. Besides, tight lending standards means less foreclosures, which means a healthy real estate market whose prices are dictated by supply and demand.
The new guidelines actually FAVOR first-timers
There is one key point in the bill regarding lending standards that no one seems to be talking about. The new underwriting standards will raise the down payment requirement to 5% from the current 3.5%, except for first-time homebuyers. This may not sound like much, but it translates to a $4,500 difference on a $300,000 home. It actually gives first-time homebuyers an edge in affordability over those buyers who have purchased homes in the past.
A step in the right direction
While the details have yet to be finalized, the new bill is definitely a step in the right direction. It will create much more of a free-market housing finance system, while maintaining enough of a safety net for lenders to encourage availability of loans.
While it may make it more difficult initially for buyers with borderline qualifications, it will encourage a new version of the American dream: where younger buyers wait until they are ready to buy carefully and responsibly in a healthy real estate market.
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