Fannie Mae headquarters in Washington, D.C.
In a talk last week with the Mortgage Bankers Association, Timothy Mayopoulos, CEO of Fannie Mae (NYSE: FNM-PK), elaborated on plans that would expand the government-sponsored entity's ability to offer low down payment mortgage options for U.S. homebuyers. For many potential borrowers, this move could be the key to making an otherwise impossible home purchase a reality.
How the home loan market works today
Since the financial crisis, the vast majority of all home loans in the U.S. come with some form of a government guarantee in a process largely hidden from the homebuyer. When a bank originates a mortgage loan, it will typically sell that loan into the secondary market. That's where entities like Fannie Mae and the other government-sponsored mortgage entity, Freddie Mac (NYSE: FRE-PK), come into play.
These entities take these sold loans and bundle them into mortgage-backed securities. Fannie and Freddie will either hold those securities on their books, or sell them as bonds to investors. Since the government bailout of these two giants, these mortgage bonds come with an implicit government guarantee.
For bond investors, this is a great deal; but for potential buyers, this system presents some tough limitations. Because the entire mortgage market more or less runs through Fannie, Freddie, and, to a lesser extent, the Federal Housing Administration, or FHA, buyers must qualify based on the underwriting criteria of these faceless giants. That means more often than not a 20% down payment is required.
Mayopoulos explained that, for many borrowers, that 20% hurdle can be too much of an obstacle to overcome. Therefore, Fannie Mae is preparing to roll out programs that could feature down payment requirements as low as just 3%.
Credit quality remains a priority
The roll out of this program should not be mistaken for a lowering of credit standards required to obtain a mortgage loan. In the case of the new 3% down payment mortgage product, Fannie Mae will require borrowers to purchase private mortgage insurance as extra protection in lieu of the larger down payment. That adds some expense for the borrower, but it also adds a layer of credit protection in the event that the loan isn't repaid.
For borrowers, the decision to pay a lower down payment must still be taken into consideration in light of their own personal financial situation. Paying a lower down payment will generally mean a larger loan and likely a higher interest rate--two factors that will raise the monthly payment requirement and could cause a cash flow problem if not properly budgeted. However, when the cash flow equation works out, the option to obtain a lower down payment mortgage could be the difference between buying a house or continuing to rent.
As the industry exists today, Fannie and Freddie are really the only secondary market players available. The number of mortgages coming through just Fannie Mae is staggering. For the first nine months of 2014, the average down payment for all of the loans backed by Fannie Mae was 23%. Fannie purchased or guaranteed 228,000 mortgage refinances and 265,000 home purchases in the 2014 third quarter. Since 2009, Fannie has purchased or guaranteed $4.3 trillion of mortgages in the U.S.
The future of housing finance
In a follow up interview following his speech, Mayopoulos sat down alongside Donald Layton of Freddie Mac to discuss the implications of the new 3% down payment program and the future of housing finance in the U.S.
As a potential future home buyer, the future looks bright. For example, a mortgage application today requires piles of paperwork, lengthy wait times, and a mind numbing procession of regulatory disclosures. Layton explains that a future loan closing should only require an iPad at the closing table. The borrower can sign digital, receive all documentation instantly, and close the loan. The originator's paperwork is automatically saved and then reported to secondary market participants like Fannie or Freddie. Today this process literally takes months. In the future it could take milliseconds.
Perhaps even more relevant to potential borrowers, Layton and Mayopoulos discussed how mortgage lenders can today utilize data to better target the exact credit standards that matter and get rid of antiquated rules that may prevent an otherwise credit worthy borrower from getting a loan. Both were quick to point out that this does not indicate a deterioration of credit standards, but instead a new capability to "target" credit worthy borrowers with better products and better service.
Both executives concluded the discussion with a promise of more announcements to come. Expect to see more tweaks to processes and requirements that will hopefully make it easier and faster to obtain a mortgage without putting the industry at risk of another housing finance bubble.
