If you're clients had trouble paying their bills lately and want to buy a home, or recently bought one with an adjustable-rate mortgage, pay attention: Lenders are making it harder for people with weak credit histories to qualify for a home loan or refinance an existing one.
Freddie Mac (FRE), the nation's second-biggest financer of home mortgages, said Tuesday that it will stop buying subprime adjustable-rate mortgages and will require more borrowers to prove they earn the income they write down on their loan applications.
While these loans helped fuel the real estate boom by allowing millions of additional families to buy homes, a surprising number of borrowers couldn't afford their mortgages when the interest rates started rising after two or three years. Almost 3 million American homeowners have these subprime ARMs that will jump to higher interest rates within the next three years. Nearly 15% of them have already missed at least one mortgage payment.
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If their credit hasn't improved, or if the value of their house has gone down, they may not be able to refinance.
"It's a tough situation," says Dick Syron, CEO of Freddie Mac. "There's a very delicate and difficult balance between getting as many people into houses as you can, and at the same time not putting people into houses they can't keep unless home prices are appreciating or interest rates are very low."
Freddie Mac's announcement shook the mortgage industry. Many of these lenders rely on Freddie Mac to buy pools of loans from them. Freddie Mac, which said the changes will take effect Sept. 1, is holding about $185 billion worth of these subprime loans, half of which would not meet its new guidelines.
Under the new rules, a borrower would have to qualify not only for the "teaser" interest rate, but also at the highest rate it could rise to. Let's say a subprime borrower wanted to buy the U.S. median-price home at $210,600 using a two-year ARM. The buyer would typically start with an 8.5% interest rate and a $1,619 monthly principal and interest payment.
But to get that loan approved by Freddie Mac, the buyer would have to prove he or she could afford the maximum rate adjustment to 13.5% and $2,412 a month. That could result in a lot of middle and moderate-wage earners who are not going to be able to qualify anymore.
Freddie Mac also said it is developing a hybrid mortgage that will provide lenders more choices for people with scuffed credit. The products will reduce the amount rates can jump, offer longer fixed-rate periods at the beginning of the loan and increase the time between rate resets.
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