Loan costs for second homes, rentals to spike under new Fannie/Freddie rule

Do residential rental properties with one to four units and second-home mortgages carry more risk? Apparently so says the U.S. Treasury Department. Such loans underwritten by Fannie Mae and Freddie Mac will end up costing you more under restrictions quietly announced earlier this year. What is the new rule? How will the new rule impact second home buyers and investment residential properties? 4 changes to watch for

What is in the new Fannie/Freddie rule

Fannie Mae is tightening the underwriting criteria for second homes and investment properties, the government sponsored entity said in a letter to sellers on Wednesday.

“Recent amendments to our senior preferred stock purchase agreement with Treasury impose additional risk criteria on the loans we acquire,” the GSE said in a letter. “One of those restrictions is a 7% limit on our acquisition of single-family mortgage loans secured by second home and investment properties.”

The new restrictions say that no more than 7% of the mortgages that lenders sell to Fannie or Freddie can be tied to second homes or investment properties. The cap is based on the overall dollar volume of loans purchased by Fannie and Freddie, though the companies are implementing the restrictions on lenders that sell them loans.

Why does this new rule change the mortgage market:

By limiting the percentage of loans sold to the government sponsored entities (GSEs Fannie Mae and Freddie Mac) the mortgage market for these loans will be transformed. Remember the two GSEs are the largest buyers of mortgages. They purchase loans from banks, mortgage brokers, etc.. and take on the risk of the loan as long as it meets their requirements. They then package and sell these loans to various buyers through bonds. As the GSEs limit loan purchases, banks will be forced to portfolio or sell these loans to other buyers at higher costs and more risk to the lender.

Four changes to investment and second home buyers

Banks become more conservative as they will have to portfolio or sell to other buyers: In a nutshell, look for lenders to become considerably more conservative on their underwriting of second home/investment property loans
Higher interest rates: Without the government guarantee for purchase, lenders will raise their rates to compensate for the increased risk. I could see rates trending similar to Jumbo loans that are ½% or more than a traditional conventional loan.
Larger down payments: with increased riskis to the lender, the easiest way to mitigate risk will be to increase down payments. For example, in the past you could get a loan with 10-15% down, under the new requirements the down payment will likely be 20-30%.
They will make less loans to second homeowners and investment property buyers: many banks will decide that the increased risk of having to hold these mortgages is not worth it and they will pull back from this market except for the highest quality loans. This is similar to the jumbo market.

How will this impact Real Estate purchases in resort communities?

There are two factors colliding that will slow the second home market. First interest rates are naturally rising as inflation pressures creep up. Furthermore, the new Fannie/Freddie rules will also increase mortgage rates at the same time.

As these two factors converge interest rates will hit a point where there is a noticeable slow down in many resort markets as the mortgage payments price buyers out of the market.

Summary

The second home market in resort communities is having a historic run with prices reaching record levels and inventory falling to record lows. I’ve been wondering how the resort markets slow down. Rising rates of mortgages along with Fannie/Freddie changes might be the catalyst to finally start putting the brakes on real estate.

Additional Reading/Resources

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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