Fannie Mae Moves to Risk Based Pricing

As of today I have received word from three lenders that Fannie Mae is moving to "Risk Based Pricing." They are stating that all Fannie Mae (FNMA) lenders will be doing the same. To the average consumer that might sound like no big deal. But let me assure you this is a very big deal for home buyers that are coming into the market right now as well as current homeowners that care about their home's value. Below I will explain why:


Under the new Fannie Mae guidelines, lenders will impose an extra cost on loans that are greater than 70% Loan to Value ratio and have credit scores are less than 680. That means that anyone with what I like to call B+ credit that is looking to buy a house with less than 30% down will find, in the very near future, that the rate they will pay is higher. Furthermore, as your credit score drops below 660 and 640 and 620 there are increasingly substantial hits to interest rates.


For those that don't know, Fannie Mae is a government created private agency that is the industry standard for how conforming loans are priced and underwritten. Freddie Mac (FHMC) is the other loan guarantor that will probably follow suit within days. In the years that I have been in the mortgage world 90-95% of the loans i have done have been FNMA/ FHMC loans. Up until this point a borrower that had a lower credit score (as long as it was greater than 620) could expect pay the same rate as one with an 800 credit score.


Analysis:
This development will have a significant impact on borrowers, and especially first time home buyers. There are two reason for this: Primarily, first time home buyers (FTHBS) tend to have lower credit scores than homeowners with a track record. This is because FTHBs have less track record of paying back major consumer debt than homeowners who have an established mortgage history. That typically leads to a lower credit score. Furthermore FTHBs almost always borrow greater than 70% of the home's value whereas move up buyers are usually bringing equity realized in their current home with them.


The damage to first time home buyers will not be the only fallout from this decision. The real estate market's recovery will be driven by buyers that, for now, are either sitting on the sidelines waiting, or that have been priced out of the market. See my post on affordability. With increased rates for many potential buyers, values will have to drop even farther to increase affordability. Essentially what that means is that Fannie Mae is forcing an even larger correction on the market than what we have already experienced.

If I can rant for a moment... I find this development especially hypocritical coming from Fannie Mae. In 2004 and 2005 as home values were increasing all over the country, FNMA made several changes to their lending guidelines that were designed to make homes more affordable. This included the advent of interest only loans and increasingly relaxed standards for stated income loans. While well intended to help borrowers qualify more easily for purchases, they had an unwanted effect of pushing home values to record levels. This is because sellers knew that buyers could qualify for larger and larger payments with these enhancements and maximized their gains accordingly. In late 2004 it started to become more apparent to me that the market was approaching the top. This is based solely on my observation that basic entry level houses were becoming unaffordable for average 1st time home buyers. As we know, values continued to grow for another 1-1.5 years to the point that almost no one could afford a home creating a value bubble. Then the market began to adjust. Of the Fannie Mae borrowers defaulting within the last 18 months I have to think that they vast majority of them were those that qualified for their homes based on those affordability enhancements. So in effect Fannie Mae contributed to the bubble and is now working like heck to slow the recovery.

As for what that means for borrowers in the future. It is more and more important to maintain excellent credit scores. If you need to find out more or want to check your credit scores contact me.