Conforming Cash-out Changes

In addition, Fannie said loans where a first lien and nonpurchase-money second lien are consolidated will now be treated as cash-out. Previously, these loans were treated as limited cash-out refinance loans. This change also takes effect on February 1st of next year.

To qualify for the revised limited cash-out refinance category, only an existing first mortgage, purchase-money second mortgage, closing costs and less than 2% cash back to the borrower (up to $2,000) can be financed in the new loan. Lenders will now need to provide written confirmation, such as a HUD-1 settlement statement, that the proceeds of a subordinate lien were used to purchase the property.

On the upside, Fannie said it will expand the loan-to-value ratios on limited cash-out refinances to the same level as purchase money mortgages, which are as high as 100%.

The changes are the result of an extensive assessment by Fannie of the credit risks associated with various types of refinance mortgages. The company said a refinance loan where the balance increases in the neighborhood of 20% or more from the prior balance is three times more likely to default than a refinance that increased the balance 3% or less. In addition, Fannie noted that inaccurate appraisal values are more likely to occur in a cash-out transaction.

Fannie said that its Desktop Underwriter will be updated in December to reflect the pricing changes.

The Washington D.C.-based company said its goal is to align its “eligibility and pricing policies more closely with the risk profile of the particular mortgage transaction.”

Freddie Mac, one of two other government sponsored housing enterprises (GSE’s) (the Federal Home Loan Bank is the third), reported in its second quarter refinance survey that 67% of sampled refinance loans it purchased included at least 5% cash-out.

FM Watch, the coalition of banks and mortgage companies that attempt to keep the GSE’s on a level playing field in terms of cost of funds, previously criticized the GSE’s for home equity lending. Gerald L. Friedman, chairman of the group, noted at a previous subprime conference that it was not congress’s intention for Fannie or Freddie to purchase loans used to finance personal and household goods — such as cash-out loans.

The Wall Street Journal (WSJ) has been a regular critic of the mortgage giant recently, saying that Fannie is exposed to too much interest-rate risk. A recent announcement from the mortgage giant, indicating that its duration gap — a measure of how well its interest-rate risk is hedged — widened to 14 months compared to its target range of about six months, was recently cited by WSJ as further evidence of excessive exposure.

Fannie’s decision affects a significant portion of the total mortgage industry. The company reported that business volume — which is the mortgages it purchased for portfolio plus mortgage-backed security issues acquired by other investors — was $159.8 billion during the second quarter of this year. On an annualized basis, this equates to $639.2 billion — a pretty big chunk of the total $2.18 trillion U.S. production currently estimated by the Mortgage Bankers Association of America for the industry this year.