Federal regulators recently announced a number of initiatives to loosen mortgage lending. Their view is that the current standards, adopted years ago in response to the financial crisis, were an overreaction, and the current tighter rules are choking off a housing recovery.
Here’s the background: After the housing bust six years ago, the government wanted to prevent another round of risky loans that led to foreclosures. So it required that lenders insist on higher down payments if they want to have Fannie Mae or Freddie Mac buy or guarantee their loans. And if lender wants to sell a loan to someone other than Fannie or Freddie, it has to require a 20% down payment or else keep part of the risk itself.
In addition, the government said that if Fannie or Freddie bought a loan that went into foreclosure and it turned out that the lender made some error in the initial paperwork years ago – even a fairly minor or technical error – Fannie or Freddie could force the lender to take the bad loan back. That’s the main reason lenders have been so obsessive in recent years about loan documentation, which has frequently delayed or even capsized loans.
Recently, though, the head regulator of Fannie and Freddie announced that the agencies would soon be able to buy or guarantee loans with smaller down payments – in some cases as low as 3%. In addition, regulators dropped the requirement of a 20% down payment in order for a lender to re-sell a loan to private investors. (Now, lenders must merely verify the borrower’s ability to pay and make sure the borrower’s total debt-to-income ratio isn’t more than 43%.)
Finally, Fannie and Freddie have reached a settlement that defines exactly what sorts of mistakes will and won’t cause a lender to have to take back a bad loan years after the fact. This should make lenders less worried, and generally streamline the documentation process.