Freddie Mac toughens Sub prime loans : Rooftop Views

Rooftop Views

Freddie Mac toughens Sub prime loans

Government-sponsored mortgage marketer Freddie Mac is the latest company to weigh in on the growing concern over lending to unqualified home buyers, saying it's tightening its standards for buying mortgages held by such borrowers.

The McLean, Virgina-based company said it would start enforcing the new standards after Sept. 1, 2007.

Shockwaves have been rippling through financial markets as more signs emerge that relaxed lending standards during the housing boom of recent years are leading to escalating defaults and rising losses for lenders and owners of securities backed by such loans.

The latest concern was sparked a few weeks ago, when banking giantHSBC said its bad-debt charges will be 20% higher than forecast, primarily reflecting deterioration for U.S. lender Household.

Among smaller lenders, the credit crunch in the market for low-end mortgages has left companies specializing in these sub prime loans at the mercy of big financial institutions. Several have already filed for bankruptcy.

For its part, Freddie Mac said Tuesday that it would stop buying those mortgages that have "a high likelihood of excessive payment shock and possible foreclosure." Instead, the company plans to buy only sub prime adjustable-rate mortgages, and securities backed by such loans, that have been qualified at the fully indexed and fully amortizing rate.

Freddie Mac also said it would limit the use of loans that don't require income verification or other documentation, and will recommend that lenders collect adequate escrow for taxes and insurance payments.

Moreover, the company said it's developing new fixed-rate and hybrid adjustable-rate mortgages with the aim of giving lenders "more choices to offer sub prime borrowers."

The firm said its new requirements cover mortgages known as 2/28 and 3/27 hybrid ARMs, which currently make up about three-quarters of the sub prime market.

Specifically, Freddie Mac said it will require that borrowers applying for these products be underwritten at the fully indexed and amortizing rate, as opposed to the initial "teaser" rate-often several percentage points below the actual rate for most of the life of the loan.

The company also will limit use of low-documentation loans, so-called "no income verification" products in combination with the 2/28 and 3/27 hybrid arms.

In addition, the company won't purchase "no income, no asset" documentation loans and will limit so-called "stated income, stated assets" products to borrowers whose incomes derive from hard-to-verify sources, such as self-employed persons and those who participate in the cash economy, the firm said in a press release.

"There will be a reasonableness standard for stated incomes," Freddie Mac concluded.