Yahoo News yesterday reported that FannieMae and FreddieMac are stepping up and proposing to make some changes to the subprime loans they are holding.
For those who need it, a little background:
Fannie Mae, and Freddie Mac are acronyms for large corporations that are generally sponsored by the federal government to provide stability in the mortgage lending marketplace. They were originally started in the early part of the 20th century as wholly owned government agencies designed to provide affordable home loans for returning servicemen, etc.
They've since been privatized but retain a government sponsorship, in order for the government to have a modicum of control over the nation's lending practices.
Both companies are MASSIVE secondary-market purchasers of already-originated mortgage loans, competing with the other typical Wall Street buyers in that marketplace. Fannie Mae has been beset with management problems and financial reporting errors in the recent past, but they remain a huge purchaser of loans that meet certain criteria.
(Fannie Mae, just this week has entered an agreement to be purchased by, you guessed it, a private equity firm who has garnered a coalition of groups, two of whom are CITI Bank, and Chase bank. The equity fund will retain majority control, while the two banks will have a minority interest. The group says it will continue to report publicly, and seeks to retain the government sponsorship, helping it retain its power and stability in the marketplace.)
Fannie Mae owns and services a large percentage of the subprime loans in the US right now. There is a morass of foreclosure looming on the not-too-distant horizon for the borrowers in this type of loan.
Typically they are called "2/28's" which means that the loan has an amortization of 30 years, and a fixed period of only two years on the front of the loan. The remainder of the loan is adjustable, according to the lenders program at the time of closing. The amount of adjustment depends upon the "caps" that were in place at the time of closing.
Most caps are typically expressed as a three-number combination that most people fail to understand, usually 6-2-6. The first number represents the amount of increased interest rate the lender is allowed to charge upon the first opportunity, the 25th month of the loan. If you have a loan at 7% on a 2/28, and your caps are 626, that means that in the 24th month your interest rate is 7%, and in the 25th month, your rate can be legally moved to 13% under this program. The second number in the combination, (2) represents the number of adjustments per year the lender is allowed to make to your loan - i.e. every six months. The third number (6) is the lifetime cap on interest rate rise for the life of the loan. This is the "safety net". Under this program, the interest rate may NEVER go above the 7% (original rate) plus 6% (the cap number), in this case 13%.
You can imagine how distressing this type of loan would be to a person who borrowed 100% of their home's value in order to get the purchase done. They have NO equity. When the loan gets ready to adjust that first painful time, they have no ability to get a refinance done, especially if home prices are in a general state of decline - which they are right now, nationally. They are poor-credit borrowers in the first place, and have no savings, no extra income, and negative home equity from which to borrow.
The borrower becomes stuck in a loan they can't get out of, with the possibility of it adjusting WILDLY at the 25th month.
Sucks to be them. Anecdotally, 900 Californians PER WEEK are losing their homes to foreclosure right now, due to this very problem. Per week.
So, as you can imagine, this situation has the industry on its ear, and everybody in a regulatory position is seeking ways to mitigate the massive losses. You've heard about lenders like New Century, Novastar, etc... the list is LONG, of lenders in trouble for having originated these types of loans, and now the Wall Street buyers are asking the lenders to buy them back, because they aren't performing. This is how lenders go out of business.
Congress is hurrying to weigh in the situation, and the Banking Committees of both houses are holding hearings to see if there is something they can do. (I hope they stay out of it, and wait for the industry to self-regulate, because they don't even understand what an "exotic hybrid mortgage" is... they will make a mess, mark my words...)
So before lawmakers can wade into the fray, the industry's biggest players are taking steps to make things better. Fannie is proposing to make adjustments to these loans for deserving borrowers. They are offering to fix the caps issue related to that first nasty adjustment, and they are also going to move the amortization out to 40 years, instead of 30 years. This will have the effect of lowering the borrower's PAYMENT by up to five percent per month. Not the interest rate, but the payment.
Sounds like a pretty good deal to me, and just in time, before lawmakers can make a lovely mess of things. It's always best to let a free market regulate and correct itself - after all, they still need to lend money, and the money still needs to perform, or the owner of the money goes out of business - that's the best motivator for change there is. Lawmaker posturing and puffing is useless, and will only have a detrimental effect on the situation.