For years, Freddie Mac® has helped put families into homes they can afford. Now, it’s taking steps to help keep them there. The company that serves as one of the nation’s largest buyers of home mortgages has announced it’s going to tighten its subprime underwriting standards (rules covering loans to those with impaired or poor credit). Its goal is to help protect borrowers from potential mortgage payment shock.
Payment shock is any sudden increase in required payment. It can occur if an adjustable rate mortgage (ARM) offers a low introductory “teaser” rate and then resets at a much higher monthly payment once the initial period has elapsed. It can also happen as a result of a jump in interest rates. If rates increase substantially at each adjustment, those who can’t afford the resulting higher monthly payment may end up defaulting on their loan.
Due to the large number of subprime ARMs that were made available during the recent housing boom, foreclosures are becoming increasingly common. So to help prevent homeowners from getting into this situation, Freddie Mac is going to start requiring borrowers applying for subprime ARMs to qualify at the fully indexed and amortizing rate, including the cost of taxes and insurance. That means those applying will have to qualify not just for the initial monthly payment being offered, but also for the potential maximum monthly payment they could end up having to cover in the future.
In order to better verify that borrowers have the necessary income to afford the home they’re buying, Freddie Mac is also going to stop buying loans that don’t require income or asset documentation and will restrict “stated income, stated asset” loans to borrowers with income that’s very hard to verify (such as the self-employed).
Senator Chris Dodd, Chairman of the Banking, Housing and Urban Affairs Committee calls Freddie Mac’s new rules, “a responsible standard that ensures borrowers will have the ability to repay their loans, thereby protecting their home equity.” But while the new regulations may protect future borrowers, there’s some concern about the impact they may have on those who already have a subprime ARM.
What should you do if you have a mortgage that’s about to reset and you’re worried you won’t be able to afford the higher payments?
Consider refinancing now. Freddie Mac’s new rules only apply to mortgages that originate on or after September 1, 2007. If you currently have a subprime ARM loan and are concerned you may no longer qualify to refinance under the stricter guidelines, you may be wise to do so now before they go into effect.
What should you do if you have poor credit and would like to buy a home in the future?
Your best bet is to start taking the necessary steps to improve your credit rating. This includes paying your bills on time and paying down outstanding debt. Not only will you benefit from an improved credit report, but the good news is that by the time you’re ready to buy, you’ll likely also have a wider choice of mortgage products to choose from. Along with tightening lending standards, Freddie Mac is also developing new hybrid ARMs designed to limit payment shock by reducing adjustable rate margins and lengthening both fixed-rate terms and reset periods.
Together with its new regulations, Freddie Mac’s new mortgage products are a definite step in the right direction towards protecting home buyers from predatory lending practices and helping them obtain homes they can afford to keep.