Say Goodbye To 95% Fannie/Freddie Home Loans As 10% Downpayment Soon To Be Required

This is a follow-up on my post on August 4th entitled, ‘MGIC Reduces Mortgage Insurance LTV’s in CA, NV, AZ and FL…The Leaves Two‘. At the time, I was extremely concerned that there were only two mortgage insurance companies left who would insure to the Fannie/Freddie maximum loan-to-value ratio of 95%. Requiring an extra 5% down in the hardest hit states will take many potential buyers out of the market. This would be yet another blow to fragile markets around the nation. Fannie and Freddie are handling some 75% of all loans in the US now and even a seemingly slight tightening of guidelines can have devastating effects.

Most do not realize this but the primary targets for home purchases are now first-time home buyers and current renters. This is a very significant market challenge that has not been brought into the light as of yet. These two groups have historically been the weakest with respect to demand. These groups are not known for large down payments.  This is where many analysts go wrong. They still look at the population at large, and assume that the groups that have always been the largest buyers will continue to be so. This is an inaccurate assumption.

The reason that first-time buyers and current renters are the primary targets is simple. It is because values are down so much (35% in CA in the past 14-months) that a large percentage of present home owners are literally ’stuck’ in their home unable to sell or refinance.  The all-important ‘move-up’ buyers do not exist to any great degree any longer because affordable mortgages are gone and many can’t even afford to re-buy the home they live in today. Lastly, ’move-down’ and ‘lateral’ buyers are not out in any great numbers either because of the two reasons above.

For these reasons, despite total sales in many bubble states surging last month, ‘organic’ sales were at all-time lows. An organic sale is me selling a home to you and not part of the foreclosure stock. Last month in CA, foreclosure-related sales made up 45% of total sales.

I now maintain that much of these sales are to speculators and not owner-occupied buyers, which presents an entirely different problem.

From my August 4th report on the Mortgage Insurance problem coming:

There could be a big problem brewing for the housing market. One that many may have not considered.  Could a large portion of the purchase market and a good chunk of Fannie and Freddie’s loan production in four states with the largest housing markets ride with two of the smaller sized mortgage insurers?

MGIC, following in the footsteps of most of their competition, reduced the allowable loan-to-value (LTV) ratios for mortgage insurance in CA, NV, AZ and FL to 90% effective today from 95%.  You can find the state restriction memo here.

If the remaining two mortgage insurers who allow over 90% in these states, Radian and RMIC, follow MGIC’s lead it would further depress their housing markets because it requires all borrowers to put more money down on purchases or bring in more money on refinances.  GE, UGI, Genworth and PMI only go to 90% and Radian and RMIC are smaller companies, so it is not inconceivable that they will not want to be the last ones on the block doing high LTV deals and soon follow suit.

Now, as of 8/25 RMIC is out of the 95% market in ’declining value’ states for all intents and purposes.  Just four months ago the market heralded Fannie and Freddie for riding to the rescue and removing their ‘declining market policy’ and allowing borrowers go to go 95% again.  But the decision is and always was out of their control. It matter not if the GSE’s will buy the loan, it matters if lenders can insure the loan.

A Mr Mortgage reader and one of the ‘good-guy’ mortgage brokers out there, Aaron Terreri of Blue Coast Home Loans in CA recently sent me this break down on what RMIC will now do. The OFHEO stipulation below takes them out of most bubble states almost immediately.

Attached are RMIC’s guidelines that will be effective 8-25.  RMIC will allow up to a 95% LTV/CLTV (90% on eligible nonconforming loans > $417,000) if all of the following are true:

• The OFHEO Index for the property’s MSA for the most recent two quarters declined by less than 2% (this one is a killer)
• The minimum loan representative credit score is 700, and
• The property is a single family detached primary residence, and
• The loan is a purchase or rate/term refinance, and
• The loan is a fully amortizing or interest only fixed rate, or ARM with a fixed rate and payment for 5 years or greater (RMIC’s minimum Interest Only term is 10 years), and
• The maximum allowable total debt to income ratio is 45%, and
• The loan is not one of the following ineligible loan or property types – investment properties, cash-out refinances, borrowers with nontraditional credit and construction perm loans, and
• If the loan does not meet “of the above criteria, the loan must meet RMIC’s requirements for Declining Markets loans

Now, by default Radian is the last man standing. But Radian is one of the weakest and there is much uncertainty regarding their ability to survive. Besides that, why would this one insurer want to take all of the 95% risky business on their own. Why would banks want to take on the counter-party risk involved with doing 95% loans through one of the weakest MI companies.

On top of it all, S&P downgraded three of the mortgage insurers last week, Radian being one of them.  My sources say that Radian will stop insuring loans over 90% by October 2008.  If this happens, say ‘goodbye’ to less than 10% down loans or less than 90% refinances for a long time. While you are doing so, say ‘goodbye’ to the ability of many in the largest target home purchaser groups, the first-time home buyer and current renter, to buy a home.

Of course, the banks could self-insure these products but that requires a significant interest rate increase, which reduces affordability and home prices as well. Always be conscious of the nasty feedback loop in which we find ourselves…higher rates equal lower home prices. Lower home prices equal increased pressure on home owners and more loan defaults and foreclosures. More foreclosures equal more supply and lower home prices. And on and on and on.

Wall Street Journal: S&P Downgrades Units of Three Mortgage Insurers

Standard & Poor’s Ratings Services downgraded its credit ratings on the units of three mortgage insurers, reflecting its expectations for increased claims and concerns about the profitability of insured mortgages originated this year.

The ratings firm, a unit of McGraw-Hill Cos., added that its projected claims for mortgages originated in 2006 and 2007 indicate that the volatility of mortgage insurers’ operating results is significantly greater than S&P assumed before the deterioration in the mortgage and housing markets.

S&P expects the 2008 vintage will generate a moderate underwriting profit for most mortgage insurers, but the significant uncertainty in the mortgage and housing markets suggests an underwriting loss is possible.

The ratings firm lowered its grades on units of Old Republic International Corp., PMI Group Inc. and Radian Group Inc., also pointing to unfavorable comparisons of the companies’ results for the first half of the year with S&P’s forecasts.

The units of PMI and Radian saw their ratings cut by two notches, to A- and BBB+, respectively, while Old Republic’s ratings got a one-notch downgrade to A+. Radian’s new rating reflects below-average credit quality. The ratings of the parent companies were also downgraded. PMI’sratings are subject to additional downgrade, withS&P noting it would likely lower its ratings another notch or affirm them with a negative outlook within 30 days. 

I believe the mortgage insurers represent significant financial sector and housing market risk that the market has not factored in as of yet.  Especially when the GSE’s make up 75% of all lending and unless the purchase market expands we have no chance of finding a bottom to the market.

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