Fannie Mae and Condo Mortgage Rates

Well, my second post and I'm already off plan!

I wanted to step back briefly from my personal search and also share/vent about larger issues that will impact me.  My current annoyance is the new financing rules from Fannie Mae.

Some background: most mortgage loans are made by banks, credit unions, or other organizations who typically keep the loan for a year or so, and then turn around and sell it to Fannie Mae or Freddie Mac.  This system has been in place for decades, and may be changing thanks to the government takeover of these companies.  Fannie and Freddie encourage loaning (and hence homeownership) by removing the risk of default from the people who make the mortgages.  If it weren't for them, then after you made a loan, you'd spend the next 30 years worrying about whether the loanee would continue making payments.  By selling the loan, you can clear your books and make a new loan.

Because of this power, Fannie and Freddie have enormous influence in how everyone else makes loans.  They won't purchase certain loans, and hence these loans will be more expensive, due to the increased risk taken by lenders.  The best example of this is the $417,000 limit in the size of a loan.  Traditionally, if you needed more money than this, you'd need to get a "Jumbo" loan.  "Jumbo" just meant "Too big for Fannie and Freddie."

Those of you who follow the news and/or listen to This American Life know that the loan-selling business is a big part of the reason why we got into the current housing mess.  Banks were making crazy loans because they wouldn't need to worry about whether people could make their payments over the next 30 years.  Fannie and Freddie's rules shielded them from the worst of this, but it was clear that they would need to be leaders on two fronts: on the one hand, continuing to purchase loans so the financial machinery that drives home-sales can continue; and, on the other hand, pushing out rules that will encourage more responsible loan origination.

In general, I'm fine with most of these changes.  For example, it makes a lot of sense to increase the required minimum credit score - more responsible borrowers are more likely to pay off their obligations, and so they should get the lowest rates.

What really ticks me off, though, is that the latest set of rules are anti-condo.  The single worst example: ANY condominium loan will AUTOMATICALLY be charged 0.75% more than a traditional single-family house.  That means that a 5% loan would instead be a 5.75% loan.  The rates climb even higher if you put down less than 30% (!!!) as a down payment.  And they may refuse to buy a loan altogether if the building includes rental units, or if there are commercial tenants.

I can imagine how they justify these rules: more condos have gone into foreclosure than traditional homes.  Once again, someone has forgotten a cardinal rule of statistics: correlation does not prove causation.  There isn't some mystical material in condominium buildings that makes them inherently more likely to cause the owners to miss payments.  No: they're more likely to be foreclosed upon because condos were the prime targets of the speculative boom.  When people were buying homes as investment properties, condos, with more affordable price tags and locations in major metro areas, were the best game in town.

The RIGHT way to fix the problem would be to focus on the root cause of the problem.  Make loans more stringent for people who are purchasing homes that will not serve as their primary residence.  And, again, make sure that borrowers are responsible (by requiring a 20% down payment and possessing a good credit score).  But don't take the lazy route of punishing all condos.

What is the effect of this change?  It's most drastic for - surprise! - people like me who live in high-cost regions with little available land.  A condo may be a lifestyle choice in a place like Chicago or Miami, but out here, it's the only game in town for people who can't slap down a cool million on a single-family detached home.  Far from being speculative tools for irresponsible investors, condos are a practical and conservative choice for first-time home-buyers.

What does this mean for me, personally?  First of all, I'm hoping that these rules change before I buy.  There seems to be growing public anger about the changes at Fannie and Freddie - not specifically due to the condo rules, but if Congress steps in to correct some other problems, I hope they will sanitize these as well.  Second, it means that I'll have to pay a higher rate, which means a less attractive home, or, in the worst case, no home at all.  An extra 1% won't kill me, but it does have a pretty dramatic impact on how much I can afford.  Third, over the long run, if it seems like these rule changes are here to stay, the net effect is that condos across the board will become less attractive.  Fewer will be built, and the ones that already exist will fall in value.  If I wait until after that finishes happening, then the net effect may be a wash for me - higher interest rate, but lower sales price, resulting in about the same total monthly mortgage check for the same unit.

I'll continue following this issue.  I was upset enough to write my representative and senators about this issue - there's no chance that my letter alone will make a change, but if enough homebuyers complain, we may see some action.  In the meantime, I'll continue my search, and hope for the best.