Wednesday, July 15, 2009

New Changes to Fannie Mae Loans

New qualifications rules go into effect for certain types of Fannie Mae loans on October 1, 2009. For 5-year ARMs and loans with temporary interest rate buydowns, the borrower will need to qualify for the loan based on the greater of the note rate or the fully-indexed rate. Here's what that means:

-- A 5-year ARM (adjustable rate mortgage) has a fixed rate for the first 5 years, and then the rate can go up or down (it is designed to go up, so don't pay attention to anyone who tells you it will go down). The interest rate for the first 5 years is generally a little bit cheaper than it would be if you got a 30-year fixed rate mortgage. In the past, you could qualify for the 5-year ARM based on the lower, starting interest rate. The assumption was that when the rate went up in five years, the house would be worth more money and you could just refinance into a new mortgage, rather than paying the higher rate. Now, you must qualify based on the fully-indexed rate, which means you have to qualify based on the higher rate.

-- A mortgage with a temporary interest rate buydown is a loan that has a lower rate for the first 1, 2, or 3 years. It works like this: if the rate for a 30-year fixed rate loan is 6%, you can buy the rate down to 3% for the first year, 4% for the second year, and 5% for the third year. After that, the rate would be the normal 6% for the life of the loan. It is expensive to buy the rate down, so not many people use this type of loan, with the exception of builders. Because builders have so much profit potential, they are able to pay for the buydown, allowing them to advertise those low interest rates you see for new construction. Many people ran into trouble with these loans because they qualified for the loans based on the lower, initial interest rate. When the rate kept getting higher every year, they couldn't afford the new payments. To prevent this from happening in the future, you now have to qualify based on the higher, long-term rate.

Both of these changes make a lot of sense, even though they may prevent some people from qualifying for as large a loan as they would like. Ignoring the fact that rates can go up and values can go down is still the standard way of thinking. Fannie Mae seems determined to change that way of thinking. Ask anyone who is stuck in an ARM they can't refinance out of, and I'm sure they would agree.

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