Fannie Mae announced substantial changes to loan underwriting guidelines. Some of the changes were stringent new ARM standards, the removal of a 7 year balloon loans, and much tighter guidelines for interest only mortgages.
Fannie Mae made its official announcement on April 30, 2010. The changes will roll out over the next 12 weeks.
These changes are intended to ensure that shaky borrowers can afford an adjustable rate mortgage not only during the first fixed term, but once the rate adjusts even higher.
Borrowers Need More Affordability Muscle For Their ARMs
The first guideline change is tied to ARMs of 5 years or less. This is a huge change which will really impact the ARM market. Mortgage applicants must now qualify based on a mortgage rate 2% higher than their note rate. For example, if your mortgage rate is 5%, for qualification purposes, you must be able to afford a 7% interest rate. The elevated qualification payment will disqualify borrowers whose debt-to-income levels are borderline.
Pop Goes The 7 Year Balloon Program
The second change is Fannie Mae’s elimination of the standard 7-year balloon mortgage. Balloon mortgages were popular early last decade. Lately, few borrowers have chosen them, though. Mostly because rates have been relative high as compared to a comparable 7-year ARM.
Interest-Only Belt Tightening
Lastly, Fannie Mae is changing its interest only mortgages guidelines. Effective June 19, 2010, Fannie Mae interest only mortgages must meet the following criteria:
1. The home must be a 1-unit property
2. The home must be a primary residence, or vacation home
3. The borrower’s FICO must be 720 or higher
4. The mortgage must be a purchase, or rate-and-term refinance. No “cash out” allowed.
Furthermore, borrowers using interest only mortgages must show two full years of mortgage payments “in the bank” at the time of closing.
Earlier this year, Fannie Mae’s sister, Freddie Mac, announced that as of September 2010, it will stop offering interest only loans altogether.
Between Fannie Mae, Freddie Mac, the FHA, and other government-supported entities, the U.S. government now backs 96.5% of the U.S. mortgage market. So long as mortgage default rates are high, expect approvals for all borrower types to continue to toughen.