As of Dec. 1, new lending guidelines from Fannie Mae (NASDAQOTH:FNMA) and Freddie Mac (NASDAQOTH:FMCC) went into effect, and they could make mortgages easier to obtain for many Americans. The changes could include faster turnaround times, lower credit thresholds, smaller down payment requirements, or a combination of the three.
It has been difficult to get a mortgage since the financial crisis, so this could easily give the real estate market a kick-start going into 2015.
Why is it so difficult to get a mortgage?
Of course, if you have great credit, low debt, a rock-solid employment history, and the ability to pay 20% down, then it isn't terribly difficult to get a mortgage. However, it can be difficult for anyone outside of the top tier, unless they want to pay up for a super-expensive FHA loan.
According to the latest Ellie Mae Origination Insight Report, the average credit score of an approved conventional borrower who is purchasing (not refinancing) a home was 754 in October. This is slightly down from the peak of 764 in 2012, but is still well into the realm of "excellent" credit.
More significantly, the average score of a rejected purchase applicant was 723, which is considered a very good, if not great, credit score. So why are "great" borrowers being denied a loan?
In a nutshell, it's because banks have been afraid to lend money to the wrong people in the wake of the financial crisis. Specifically, Fannie and Freddie's guidelines regarding when lenders could be penalized for making mistakes have not been clear -- until now. The newly issued mortgage guidelines are designed to let banks and other mortgage lenders know exactly when they should approve and reject a loan.
The new guidelines are all about clarity, not risky lending
Fannie Mae and Freddie Mac now have a credit score "floor" of 620 and a minimum down payment requirement of 5%, which they are considering lowering to 3%. This is nothing new. However, whereas the former lack of clarity made lenders reluctant to lend to borrowers who were even near the thresholds, the new guidelines make it abundantly clear which mortgages Fannie and Freddie will and will not buy.
Now, when I say mortgages are getting "easier" to obtain, there are a few caveats. First, it will still be a challenge to find a conventional mortgage with a 620 credit score and 5% down. And for riskier loans -- e.g., where applicants have lower credit scores and low down payments -- buyers can expect costs to increase accordingly.
For example, a buyer with a credit score in the 620 range may find it easier to get a mortgage, but they can expect a higher interest rate. And buyers with the smallest down payments (like 3%, if that gets approved) can expect mortgage insurance premiums to be higher.
How big of an impact could this have?
The impact could actually be pretty big. According to the Urban Institute, if mortgage availability were at "normal" levels, we could see an additional 1.2 million home loans per year.
To put this in perspective, consider that the median sale price of U.S. homes is about $208,000 currently, so the typical buyer putting 20% down would finance about $166,000. By this rough estimate, an additional 1.2 million loans could produce around $200 billion in additional mortgage volume. Bear in mind that this is actually pretty conservative, given that the median home figure referenced here refers to existing homes. Some mortgages will be for new constructions, which have a significantly higher median sale price.
Considering that the total amount of home loans originated this year is expected to be right around $1 trillion, this implies that the new mortgage guidelines could increase homebuying activity by more than 20%.
This many new buyers in the marketplace could have a tremendous impact on the real estate market.
How this could benefit buyers and homeowners
The most obvious benefit is for people who want to buy a house and have had trouble with the mortgage process in recent years. Lenders will now have a much firmer idea of whether or not you qualify for the loan you want.
This could also be good news for homeowners looking to sell, as a 20% surge in potential buyers could mean drastically increased market activity and quicker sales.
And finally, adding clarity to the mortgage guidelines is an important step forward in the continued housing recovery, as it will help the mortgage market return to a "normal" level of accessibility, which will create a more natural housing marketplace for both buyers and sellers.