Important Changes to Freddie Mac Purchases of Nontraditional Mortgages
(July 13, 2007)
As directed by our regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), we are announcing changes to our requirements for the purchase of nontraditional mortgage products consistent with the practices referenced in the federal banking agencies' Interagency Guidance on Nontraditional Mortgage Product Risks (Guidance) issued in final form in October 2006. Our special July 13 Single-Family Seller/Servicer Guide (Guide) Bulletin [PDF 183K] implements changes to our underwriting requirements for the following mortgage products that we're collectively referring to as nontraditional mortgages: Initial InterestSM Mortgages; other ARMs and fixed-rate mortgages with an interest-only component; and ARMs with the potential for negative amortization, such as payment option ARMs which we purchase on a limited, negotiated basis.
It is important that you thoroughly review this Bulletin [PDF 183K] and the information below for details on changes to our requirements for these specific nontraditional mortgage products and the effective dates. The changes are effective for these nontraditional mortgages with loan application dates on and after September 13, 2007.
OFHEO indicated they are directing both GSEs to consistently implement the changes outlined in this email and our July 13 Guide Bulletin. We share the views of OFHEO and the federal financial institution regulatory agencies that because these nontraditional mortgages are complex and entail the possibility of payment shock, it is important that:
- Underwriting standards for these mortgages are consistent with prudent lending practices.
- Prospective borrowers have clear and balanced information prior to choosing a mortgage product.
- Borrower repayment capacity is adequately assessed when underwriting mortgages that have the potential
for payment shock.
The principles expressed in the Guidance, and the requirements we, announced, address these concerns. It is Freddie Mac's expectation that Sellers will comply with the Guidance, and that regulated Sellers will do so in a manner consistent with their regulators' interpretation and application.
OFHEO also has directed Freddie Mac to adopt practices consistent with the July 10, 2007 Interagency Statement on Subprime Lending. We will be following up with communications about this in the near future.
Effective Dates
If you're a federally regulated Seller, or regulated by any state regulator that has adopted the Guidance, be sure to review the additional implementation information in the July 13 Guide Bulletin and summarized later in this email. OFHEO indicated to us that, based on discussions it has had with the regulatory agencies, regulated financial institutions should have already implemented the Guidance. OFHEO has expressed a desire that we implement these changes as soon as possible. However, we recognize your need for advance notice to implement the changes within your organization. As directed by OFHEO, we are making the changes summarized below and included in today's Guide Bulletin effective for:
- All Master Agreements, and all Master Commitments without Master Agreements, entered into after
July 13 that allow the purchase of nontraditional mortgages with loan application dates on and
after September 13, or
- At the earliest permissible date allowed under your Master Agreement for sales of mortgages under negotiated
terms of business (see Negotiated Terms section below.)
We strongly encourage you to consider adopting these changes sooner than the timeframes above wherever possible.
Changes for Nontraditional Mortgages
The requirements in the July 13 Guide Bulletin apply prescriptive, risk-based standards for originating the nontraditional mortgages referenced above. It is important that you review the Bulletin for complete requirements that include:
- Qualifying the borrower using a monthly housing expense that includes, but is not limited to, the principal and
interest payment on the mortgage, and using a principal and interest payment that is based on a fully amortizing payment schedule for the term of the mortgage.
- For nontraditional fixed-rate mortgages, qualifying the borrower using payments calculated using the note rate; for nontraditional ARMs, qualifying the borrower using payments calculated at the higher of the note rate or the fully indexed rate. Note that the fully indexed rate is the sum of the Margin plus a value of the applicable Index at any time within 90 days preceding the note date, rounded to the nearest one-eighth of 1% (0.125%).
- Addressing initial rates for nontraditional ARMs, and mortgage file documentation that demonstrates the
reasonableness of stated income.
- Requiring you to represent and warrant that you have implemented processes and controls to ensure that borrowers with these nontraditional mortgages receive written disclosures addressing certain criteria, such as payment shock.
As part of our normal quality review process, we will now be checking for Guidance compliance.
Additional Information for Regulated Sellers
The July 13 Guide Bulletin also includes important information for regulated Sellers. We expect that you will comply with the Guidance in the manner and timeframe required by your regulating agency. We provide instructions in the Bulletin for Sellers that intend to implement an alternative approach that is consistent with the Guidance as interpreted and applied by their regulators, such as different implementation timeframes or alternative underwriting requirements. If you intend to implement an alternative approach, you will need to review the instructions in the Bulletin.
Important Information About Negotiated Terms of Business
- If you have negotiated terms of business for products covered by the Guidance, including interest-only mortgages and other nontraditional mortgage products, we will be working with you directly on the timing and scope of any necessary contract changes.
- If your Master Agreement or Master Commitment includes 90-day implementation language that provides for changes consistent with the Guidance, we will be notifying you in writing beginning July 20 and thereafter that we are invoking the provision. For most Sellers, this language reads, "With respect to Mortgages delivered pursuant to this Agreement, in the event that Freddie Mac modifies any of its purchase requirements consistent with the principles of the Interagency Guidance on Nontraditional Mortgage Product Risks, Seller will adopt those modifications as quickly as possible, but in any event no later than 90 days after written notification from Freddie Mac of such modifications."
- Affected contract provisions will be updated prior to the expiration of this 90-day timeframe.
- All new contracts issued on or after July 16 will include updated terms of business language that is consistent with our new requirements for nontraditional mortgages.
Changes to Bulk Purchase Requirements
We're implementing changes that are aligned with the intent of the Guidance for all bulk transactions. For bulk transactions that include nontraditional mortgages with loan application dates on and after September 13, we will purchase only nontraditional mortgages that were underwritten according to requirements that include the above.
Changes to Loan Prospector Assessments
We plan to implement changes to Loan Prospector® on August 12 that will reflect these changes to our Guide requirements for assessments. More information on specific changes to Loan Prospector is available on LoanProspector.com. At this time, we do not anticipate changes to the selling system or other Freddie Mac systems used for delivery.
Through conversations with many of our customers and our selling and servicing advisory board members, we know that you have concerns about the implementation timeframes. At the same time, we know that you support our shared position of promoting responsible lending and successful homeownership through efforts that contribute to an efficient and vibrant housing finance system. Once you've completed your review of the July 13 Bulletin [PDF 183K], as always, contact your Freddie Mac representative for additional information.
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