Fannie Mae’s Looser Lending Requirements Reminiscent Of Sub-Prime Practices by Amanda Maher
It was almost a year ago to the day when federal regulators sent shock waves through the investment community by announcing a plan to loosen lending requirements, namely, by reducing the minimum down payment to as low as 3% in order to qualify for selling loans to Fannie Mae and Freddie Mac.
The rationale was that the new guidelines would help boost homeownership among those who were otherwise qualified borrowers but who may not have the resources for a substantial down payment. In order to qualify for these 3% down loans, most banks require borrowers to have high credit scores. The net effect was that few people have really benefited from the lower down payment standards.
Advocates cried foul, arguing that lower-income residents, especially minorities, don’t always have traditional sources of income or credit histories. In August, Fannie Mae responded by revising guidelines to allow lenders to consider income from non-borrowers within a household toward qualifying for a loan.
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This still wasn’t good enough for advocates.
On Monday, Fannie Mae announced that it would ease lending requirements even further by:
- Allowing lenders to use employment and income information from a database maintained by Equifax to asses a borrower’s ability to repay a loan;
- Easing the lender process for granting loans to borrowers who don’t have a credit score by allowing them to enter an applicant’s data into an automated system (vs. a burdensome manual-entry evaluation process that’s currently required); and
- Requiring lenders to begin collecting “trended” credit data from Equifax and TransUnion, starting in mid-2016, a move that some suspect will allow lenders to offer better terms to customers who have a history of positive credit activity, such as paying their credit card bills off in full each month.
No credit score? No pay stubs or tax records? No problem. Getting a mortgage will be that much easier, and may indeed increase homeownership opportunities. TransUnion estimates that roughly 26.5 million consumers whose data can’t be scored under traditional models will have scores using its trended data, for instance, of which 3 million fall in to prime or super-prime categories.
But looser standards put Fannie Mae – and its investors – at risk.
The cumulative impact of (a) lowering the required down payment amount, (b) considering non-borrower household income toward a person’s qualifications, and (c) doing away with extensive due diligence about a person’s credit worthiness is awfully reminiscent of the lending practices that led to the 2007 sub-prime mortgage crisis. Throw in the fact that many first-time homebuyers today are also saddled with incredible student loan and credit card debt and it’s a recipe for disaster.
How quickly our memories fade.
It was less than a decade ago that low credit borrowers fueled a wave of massive defaults—defaults that contributed to the collapse of major financial intuitions and which all but halted the flow of credit to customers leading in to the recession.
Fannie Mae is setting the stage for this to happen again by forcing banks to lend to people most at risk for defaulting. Though Fannie Mae guarantees to pay its investors if loans become delinquent, Fannie Mae (and Freddie Mac) has not been building the cash reserves necessary to withstand another wave of delinquencies. Under these conditions, the thought of another bailout is not unreasonable. And we all know how that turned out. Fannie Mae and Freddie Mac’s investors are still waiting to capitalize on the profits the companies’ have earned since entering conservatorship.
Lenders have the benefit of 20/20 hindsight; implementing their own prudent lending requirements will be a smart way to insulate their capital despite what will likely be an onslaught of GSE delinquencies down the road.