Adjustments on Adjustable Rates Seen
If you are planning to finance a home with an adjustable rate mortgage, get ready for a few surprises.
The first is that rates are remarkably low, with some lenders promising introductory rates as low as 5% when they were more than 7% only a year ago.
That makes payments far more affordable and could make it possible for thousands of prospective home buyers to get into the house of their dreams.
The bad news is that despite these low rates, it is going to be harder to qualify for an adjustable loan starting this spring. That’s because the Federal National Mortgage Assn., better known as Fannie Mae, is tightening its lending standards. And where as Fannie Mae goes, so goes the bulk of the mortgage lending industry.
It is important to note that Fannie Mae is not a lender. It is a congressionally chartered organization that buys home mortgages from lenders, then re-packages and sells some of these loans to investors as mortgage securities. However, the company does such a volume of business that when it proposes a rule, the rule usually becomes an industry standard.
Already many private lenders are saying they’ll adhere to the Fannie Mae guidelines, which will affect home mortgages under $202,300. Some say they’ll apply the new guidelines to their jumbo loans--those over the Fannie Mae limits--as well.
In a nutshell, Fannie Mae is raising minimum qualifying standards for adjustable rate loans.
Fannie Mae’s new rules say that the minimum qualifying rate for any loan cannot be lower than 7%--no matter how low the offered introductory rate.
And in some cases, the qualifying rate will have to be higher. Specifically, if the mortgage has a 2% annual adjustment cap, a term greater than 15 years and a loan-to-value ratio of more than 75%, the borrower must be qualified at the maximum rate they could be charged at the beginning of the second year.
Some lenders now qualify adjustable loan borrowers based on the introductory rate, which can be substantially lower than the “fully phased-in” rate. (The fully phased-in rate is what buyers will pay after the end of a defined introductory period, assuming that rates stay constant.)
What does that mean in dollars and cents? Let’s take a look at an individual who wants to take out a $100,000 adjustable rate mortgage.
Assuming this person’s lender would normally allow him to qualify at the bank’s introductory rate of 5.5%, he would need an annual income of $24,334 to qualify for the loan, assuming also a standard 28% housing expense-to-income ratio. Monthly mortgage payments would amount to about $568, exclusive of taxes and insurance.
If he had to qualify at the 7% rate, his annual income would have to be $28,513 annually. But if he was only putting 20% down on a 30-year mortgage that had a 2% annual adjustment cap, he’d have to qualify at a higher rate, probably about 8.5% now. That would mean his annual income would have to be at least $32,954 to qualify. Nevertheless, his payments would still be only $568 monthly for the introductory term.
If lenders do not want to sell their loans to Fannie Mae, of course, they don’t need to follow these tighter guidelines. But most want the ability to sell their loans, so they adhere to the Fannie Mae standards regardless of whether or not they are planning to sell the loans, lending experts say.
Fannie Mae is doing this because interest rates are at 15-year lows and many are convinced that rates will swing back up at some point in the future. Rising interest rates are sure to spur loan defaults, said Forrest Pafenberg, director of real estate finance research at the National Assn. of Realtors in Washington. And to avoid this risk of default, Fannie Mae is making sure that its lenders don’t qualify buyers at unrealistically low rates.
Said Gene Eisman, a spokesman for Fannie Mae: “It doesn’t do anyone a favor to put them in a house that they can’t afford to keep.”
Eisman added that the new guidelines should have a limited short-term impact, since the vast majority of buyers are now opting for fixed rates. Nevertheless, buying a home will become a bit more difficult, particularly for first-time home buyers who need to stretch to get into a new home.
Additionally, there could be a greater impact when rates start rising again, because that’s when adjustable loans look comparatively more attractive. And since most buyers do only put 20% down on a 30-year mortgage, they’ll be faced with the more restrictive of the two new Fannie Mae rules, meaning that they’ll need to qualify at the highest possible rate. In some cases, they’ll find it’s easier to qualify for a fixed-rate loan.
