Government-sponsored mortgage repurchaser Freddie Mac says that beginning Sept. 1 it will buy subprime adjustable-rate mortgages only if buyers are qualified at the fully indexed and fully amortizing rate.
Freddie Mac will also limit the use of low-documentation underwriting for subprime ARMs and “strongly recommend” that lenders collect escrow accounts for borrowers’ taxes and insurance payments.
In instituting new, tougher standards for qualifying borrowers who take out hybrid ARMs such as 2/28 and 3/27 loans, Freddie Mac appears to be a step ahead of lawmakers and regulators.
In September, federal banking regulators issued new guidance to federally chartered banks, saying they should qualify borrowers using payment-option and negative-amortization mortgages using the fully indexed rate.
Pointing to the potential for “payment shock” and a rise in delinquencies and foreclosures, influential Democrats on the Senate Committee on Banking, Housing and Urban Affairs want the guidelines extended to hybrid ARMs, a move opposed by the mortgage lending industry.
Groups like the Mortgage Bankers Association say that market forces have already prompted many lenders to tighten underwriting standards, and that additional restrictions on the use of specific loan products will make it harder for consumers to choose the type of loan that best fits their circumstances.
Freddie Mac said it is developing fixed-rate and hybrid ARM products that will provide subprime borrowers with more choices while reducing payment shock. The hybrid ARMs will limit payment shock by offering reduced adjustable-rate margins, longer fixed-rate terms and longer reset periods.
Freddie Mac’s new restrictions on low-documentation subprime ARMs include limiting the use of stated-income products to borrowers whose incomes are from sources that are difficult to verify, including those who are self-employed. The company will no longer purchase “no-income, no-asset” documentation loans.
Beginning Sept. 1, subprime ARM loans must also be underwritten to include taxes and insurance, and Freddie Mac will “strongly recommend” the collection of escrows for taxes and insurance, as is the norm in the prime sector.
Freddie Mac said it’s not practical to require subprime lenders to collect escrows for taxes and insurance because the “maintenance of escrow accounts requires significant infrastructure and is not widely used in the subprime sector.”