Freddie and Fannie Future in Limbo

We know Fannie Mae and Freddie Mac continue to bleed billions of dollars. The two lost a total of $188.4 billion in the past nine quarters. The Federal Reserve has bailed them out to the tune of $1.1 trillion in home loan bonds bought by the Fed. The Treasury Department has bought another $191 billion and just gave Fannie and Freddie a blank check to keep the cash register running for at least another year.

So when will Fannie and Freddie put on the breaks and stop fueling U.S. mortgages?Right now, Fannie and Freddie own or guarantee $5.5 trillion of the $11.8 trillion U.S. residential mortgage debt. They financed almost 75% of new U.S. mortgages this year and there's no sign they plan to stop right now.

If the U.S. government were to stop or slow funding for new mortgages, the weak U.S. housing recovery would certainly stall. The U.S. can't even think about reversing mortgage lending by Fannie and Freddie until private mortgage lenders renew their activity in the market. Without Fannie and Freddie's strong involvement in the mortgage market, sources for mortgages would dry up and mortgage rates would skyrocket.

A report was due out at the end of December to lay out future plans for Freddie and Fannie, who are now 80% owned by the Federal government. But the report has been put off indefinitely. President Obama is expected to address preliminary plans in February, but the signal has already been given that a final report won't be ready.

In a an appearance on CNBC Tuesday morning, Rep. Barney Frank, Chairman of the House Committee on Financial Services, called the two mortgage giants a "public policy instrument of the government." Clearly he doesn't intend to rock the boat right now. Until the private mortgage market recovers, I suspect we'll continue to see the government pump up Fannie and Freddie to aid in the recovery of the housing market. With the Treasury Department's Christmas Eve blank check that lifted a $400 billion cap on the lifeline for the two companies (and showered multimillion bonuses on their chiefs), there's no doubt direct government support will continue indefinitely.

While the government is not putting on the brakes for Fannie and Freddie lending, it is seeking to change the rules for the subprime market through FHA:
  • Borrowers will need to put more money up front. Right now borrowers can put down as little as 3.5 percent. That will probably be raised to 5%, but legislation is needed in Congress. Private lenders today require between 10% and 20%. Most want 20% unless your credit score is above 750. Private lenders fund most of these loans through Fannie and Freddie.
  • Borrowers likely will have to pay more in insurance premiums. Right now that premium is 1.75% of the loan value plus 0.5% or 0.55% per year.
  • Sellers will be restricted by how much they can help the borrower. Right now a seller can pay as much as 6% of the home's value in closing costs. The maximum level is expected to be lowered to 3%.
  • Borrowers may need better credit scores. Right now the score can be as low as 500. While that's the law, lenders don't usually accept scores that low. The FHA is expected to raise that minimum score. This may not be as noticeable as the other changes because most lenders do expect a higher score, but this change will prevent abusive lenders from lending to unqualified borrowers.
These changes have not yet gone into effect and some require Congressional action. If you are planning to buy a home using FHA act quickly to avoid having to live with these more stringent guidelines.

Lita Epstein has written more than 25 books including The 250 Questions Everyone Should Ask About Buying Foreclosures.
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