The Problem with Fannie’s and Freddie’s New 97 Percent LTV Products

Last December, Fannie Mae (Fannie) and Freddie Mac (Freddie), announced they would begin purchasing mortgage loans made to borrowers with as little as three percent down. This is an important and generally positive development that will provide a badly needed expansion of credit to well-qualified homebuyers, particularly those who could afford a home but could not or would not take on the additional costs associated with an FHA loan.

In a statement endorsing these new loan products, Director Mel Watt of the Federal Housing Finance Agency (FHFA), which regulates Fannie and Freddie, pointed to housing counseling as one of the features that are designed to ensure the safety and soundness of these loans, because housing counseling “improves borrower loan performance.” While research has repeatedly demonstrated that loans made to borrowers who have participated in pre-purchase counseling perform better than loans made to comparable borrowers who have not, the unfortunate reality is that the Fannie and Freddie 97-percent LTV loans do not actually require housing counseling, at least not the counseling that has been studied and shown to improve loan performance.

Rather than requiring homeownership counseling, the Freddie product merely requires homebuyer education. The critical distinction is that whereas homebuyer education offers a generic, one-size-fits-all approach, homebuyer counseling works closely with the prospective homebuyers and provides guidance that based on each client’s unique circumstances (e.g., savings, credit score, income). While homebuyer education is undoubtedly valuable, it lacks both the depth and personalization of counseling and has been found to be less effective.

For its regular Fannie Mae mortgage product, Fannie has no counseling or education requirement for its 97 to 95 percent LTV applicants.  For its My Community Mortgage applicants, Fannie requires homeownership education and counseling that complies with the National Industry Standards or a comparable standard. Unfortunately, the Fannie product only requires this education and counseling for some homebuyers with its My Community Mortgages, which generally requires the homebuyer to have an income at or below 100 percent of the area median income (AMI). For My Community Mortgage homebuyers, the requirement only applies to these applicants:

• All borrowers are first-time home buyers;
• All borrowers are relying solely on nontraditional credit to qualify for the mortgage loan (regardless of loan product or home-buyer status); or
• The loan LTV is above 95% up to 97% (at least one borrower must be a first-time home buyer).
Fannie and Freddie should simply require counseling to be provided by a HUD-approved counseling agency. HUD-approval is the gold standard for counseling agencies and will soon require that all counselors become certified according to a congressionally mandated written examination.