Fannie Mae Requires Better Credit, Less Debt

Fannie Mae (the bloated, greed-driven organization that hasn’t served a viable purpose in decades) is now requiring higher credit scores and lower debt-to-income ratios for borrowers. I’m all for tighter underwriting guidelines within the mortgage industry, and better regulation to boot. But I don’t think it should be coming from Fannie Mae.

But before I fly into an anti-Fannie tirade, let me present you with the facts:

What is Fannie Mae Anyway?

The shortened name for this company makes it sound like somebody’s aunt. Hardly. This behemoth financial organization was formed in the 1930s, in direct response to the Great Depression. The Federal National Mortgage Association was designed to increase liquidity (available cash flow) within the mortgage industry, namely by purchasing loans made by primary lenders. It was originally a government agency, but was privatized in the 1960s to divorce it from the federal budget.

Their Relationship to Mortgage Lending

As mentioned above, Fannie Mae was made into a private corporation in 1968. Four decades and quite a few scandals later, it is still buying and selling mortgage loans through the secondary mortgage market (definition). Here’s how it works. You get a mortgage loan from Wells Fargo, Citi, or some other primary lender. That bank turns around and sells your loan (along with many others) to Fannie Mae.

Fannie will keep some of these loans on their books, but they’ll also “bundle” and sell a lot of them as mortgage-backed securities (MBS) through Wall Street. They make a ton of money doing this. How much money? Who knows! Based on everything I’ve read, the federal government is not smart enough to audit their books, complex and mysterious as they are.

What does this have to do with you and the mortgage loan you want? Well, in order for a bank to sell their loans to Fannie Mae, those loans have to meet certain underwriting guidelines. The borrower has to have a certain credit score, a certain debt-to-income ratio, a certain income level relative to the loan amount … you get the idea. This is referred to as a conforming loan, because it conforms to Fannie Mae lending guidelines. If it doesn’t conform, then Fannie probably won’t buy it. And the lender is stuck with it. And if the borrower later defaults because it was a risky loan to begin with, then the lender eats the loss.

New Credit Score and Debt Requirements

The Washington Post recently reported that Fannie Mae has tightened its guidelines for borrowers. Under the new standards, Fannie will only buy loans where the borrower has a credit score of 620 or higher, and a debt-to-income ratio below 45%. Previously, the credit score cutoff was 580.

By the way, “debt-to-income ratio” (or DTI) refers to the amount of money you pay toward your debts each month, relative to your monthly income. If you spend more than 45% of your income on your various debts, then your DTI is too high.

If you ask me, these changes are a good thing. People with lower credit scores and higher debt levels are at a higher risk of defaulting on their loans. I’m actually glad to see that we are returning to the days of reasonable lending restrictions … the days when homeownership was something you had to work hard to achieve. In the grand scheme of things, this can only strengthen our economy and help prevent future disasters.

But I still think Fannie Mae needs to be dismantled, like yesterday. And I’m clearly not alone in this sentiment.

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