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Fannie Mae to relax PMI requirements,
saving home buyers money

Fannie Mae to require less private mortgage insurance Low down payment mortgages already are easy to get. Now they'll be a little bit cheaper, too.

Fannie Mae said that, starting in March, it will let the lenders it works with require less private mortgage insurance on some low-down loans.

The relaxed restrictions mean borrowers who take out 30-year, fixed-rate mortgages stand to save $10 to $30 a month, or more than $2,000 total.

"We can begin offering home buyers the best of both worlds -- lower down payments and new options to lower their mortgage insurance costs," Franklin Raines, Fannie Mae's newly appointed chief executive officer, said in a Jan. 15 speech announcing the changes.

Protecting lenders from default
Known colloquially as "PMI," private mortgage insurance protects mortgage lenders against low-down payment borrowers who default on home loans by providing a way for mortgage companies to recoup the costs of foreclosure. Home buyers pay for the coverage in monthly installments.

"This is good news for consumers," Raines added in his remarks at the National Association of Home Builders conference. "While U.S. homeownership rates have reached record levels today, we can -- and should -- extend this dream to more families."

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For people new to home buying, it's difficult to understand that lenders often don't set their own rules when it comes to doling out mortgage money. That's because they usually turn to Fannie Mae and Freddie Mac -- the company's sister agency -- as a source of money to lend.

The process works like this: Borrower "A" wants to get his own place. The local bank wants to lend him the money and make more money off the interest. But the company doesn't want to get stuck holding the bag if interest rates rise, which could leave it collecting 7 percent on a mortgage but paying out even more to depositors from whom it gets the money.

Selling to Wall Street
Enter Fannie Mae and Freddie Mac. They buy home loans, package them together and sell them to Wall Street investors as securities that yield, say, 6.5 percent on a bundle of 7 percent mortgages. By selling loans this way, a bank gives up some of the interest it would have collected but insures itself against the aforementioned danger of climbing rates. The agency and lender each collect 0.25 percent for their work, and the borrower starts worrying about more important things, like new window treatments.

How to take advantage
of the program

  • DECIDE whether a 30-year fixed rate mortgage is the best option. That is the only type of loan that will be eligible for reduced mortgage insurance in early March.
  • ASK prospective lenders if they use Fannie Mae's Desktop Underwriter computer system to evaluate loan applications. The system connects lenders with the quasi-governmental agency electronically, allowing the company to determine whether it may approve an application in a matter of minutes, gather more information first or reject it altogether.
  • FIGURE OUT if you have extra money available to pay up front. Customers who can afford to pay a small percentage of their loan amount at closing can reduce the amount of insurance they need even more, increasing their potential savings.
  • THE REST of the loan process will be similar to what all borrowers experience. Read up on the basics here.

In order to get Fannie Mae and Freddie Mac to play ball, however, lenders have to follow certain guidelines when making their loans -- neither agency wants to buy a bunch of mortgages that will turn sour.

Historically, that meant Fannie Mae would buy mortgages where a borrower paid just 5 percent down only if 30 percent of the loan balance was covered by private mortgage insurance. The agency felt that level of coverage allowed people to get into homes without a lot of money up front, while also adequately protecting lenders.

Popular anger over PMI requirements simmered among borrowers and industry types, though, because the increase in monthly payments caused by added PMI premiums kept some people out of the loan market. Plus, consumers don't benefit from PMI policies the way they do from car insurance in the event of a wreck; should they go into default, lenders -- not homeowners -- are the ones who collect.

Legislation helps borrowers
Recently, the frustration boiled over, turning anger into action. In July, President Clinton signed legislation that makes it easier for borrowers to cancel PMI once they pay their mortgages down to a certain level. And during an October speech, Fannie Mae's outgoing chief executive, James Johnson, made it clear the agency was interested in finding ways to lower the cost of insurance for consumers.

The net result is this year's initiative. Beginning six or seven weeks from now, lenders who use Fannie Mae's Desktop Underwriter computer system to make loans will be able to insure a smaller part of their 30-year fixed mortgages. Officials say the so-called "DU" system makes it easier to spot financially troubled borrowers, allowing them to reduce the coverage level without increasing their exposure to risk.

Fannie Mae financed about a quarter of the mortgages originated last year, with about 2 million of those loans processed through DU, according to spokesman Gene Eisman. The agency expects about 150,000 home buyers to take advantage of the reduced insurance program this year.

On loans for 95 percent of a home's appraised value, known as "95 percent loan-to-value" mortgages, the agency will require only 25 percent of the loan be covered, rather than 30 percent. For 90 percent loan-to-value mortgages, the required coverage level will drop to 17 percent from 25 percent.

That means the monthly premium on a $100,000 mortgage made at 95 percent loan-to-value with a 7 percent rate would fall to $56 from $65, according to Fannie Mae estimates. Since PMI likely would be in place until the borrower reached 22 percent equity -- a process that would take 142 months with no prepayments -- overall savings would come to $1,302.

Borrowers also will have the option of paying a portion of their loan amount up front or accepting a slightly higher mortgage rate to reduce their monthly insurance costs even more. By paying three-quarters of a percentage point, or 0.0075 of their loan, for instance, the sample borrower above could shrink the premium to $40 a month. That would save $2,800 until PMI could be canceled, after subtracting the $750 cost of the move.

Positive effect
"The reduced MI should translate into lower insurance costs for the consumer," says Frank Filipps, chief executive officer of CMAC Investment Corp., a mortgage insurer based in Philadelphia. "From their perspective, that should be positive, allowing, on the margin, more consumers to be able to qualify for a mortgage."

Lenders plan to drill that message home, too, according to Michael Prach, executive vice president of East/West Mortgage Co., based in Peabody, Mass.

"We'll use it to our advantage and be able to offer it to our clients out there," says Prach, whose company originates loans in a handful of New England states. "We're here to try to get the best programs for our clients, period, and if this only enhances or increases that, then great."

Prach says he also sees more opportunities for low-down payment borrowers if Fannie Mae is satisfied with the results of the 30-year loan program and expands it to other types of mortgages.

"We expect, over time, as we've kind of seen the whole industry change and open up, they'll be less restrictive," Prach says. Among mortgage insurers, "there is some resistance out there, but they know if they don't jump on board and participate with it, they're going to lose the whole kit and caboodle."

As far as Freddie Mac is concerned, similar measures probably will be announced over the next 30 to 60 days, says spokeswoman Sharon McHale. The agency attempted to garner approval from Congress last fall to develop alternatives, with its lenders, to mortgage insurance, but the efforts were blocked. This time around, Freddie Mac plans to reduce insurance costs with a more conventional approach.

"That's the direction we're heading in if those kinds of structures benefit the borrower, which is our mission," McHale says. "We just don't have clarity now around exactly what it is we're going to do, but I think it's pretty clear we're continuing to head in the same direction as Fannie."

-- Posted: Jan. 21, 1999
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