Fannie Mae and Freddie Mac are taking steps toward reform, but “lots of work remains,” according to the latest American Enterprise Institute (AEI) Housing Market Indicators report. The GSEs should make changes to their activity in the high debt-to-income loan sector, the high combined loan-to-value ratio sector, and the refinance market, according to AEI.
After loosening through March, credit tightened for three consecutive months, as of August, according to AEI, which reported a 0.3-percentage point year-over-year decline in the national mortgage risk index. The trend was present not only at Fannie Mae and Freddie Mac, but also at the FHA.
The report focused on the GSEs’ progress toward housing finance reform and their alignment with their stated mission. “Bottom line: the GSEs have taken some steps in the right direction, but lots of work remains,” AEI stated.
Simply put, “The GSEs core mission should be to assist low and moderate income homebuyers in acquiring a primary residence,” AEI stated.
Overall, about 21% of GSE loans have a mortgage risk index of at least 12%. The biggest risk factors are refinances, loans with debt-to-income (DTI) ratios greater than 43%, and loans with combined loan-to-value (CLTV) ratios higher than 95%. AEI calls for eliminating these loans at the GSEs.
AEI pointed out that there has been a notable decline in the share of GSE loans with DTI ratios greater than 43%. A decline in higher DTI loans is typical around January each year, but this year’s decline “has been more pronounced,” according to AEI, which noted that Fannie Mae and FHA have stated they plan to step back from high-DTI loans and risk layering. “Time will tell whether this trend is a sustainable one,” AEI stated in its report.
AEI criticized the GSEs’ participation in the high-cost loan market. In 2017 the GSEs’ held about 5% of the non-conforming loan market. Today, they hold between 3 and 4%, but AEI pointed out that this drop in share is partially due to rising conforming loan limits. AEI advocates for the GSEs exiting the high-cost loan market altogether.
Another area of the market the GSEs should exit, according to AEI, is the cash-out refinance sector. Cash-out refis “do not help in the acquisition of a primary residence and are risky acquisitions with an NMRI of 10.5%,” AEI stated.
Currently, the GSEs account for 65% of the cash-out refi market, according to AEI.
Another change AEI called for in the report is to limit the GSEs to a maximum CLTV ratio of 95%. Doing so would eliminate competition between the GSEs and the FHA while also decreasing GSE risk.
Second home and investor home loans make up more than 10% of purchase loans at the GSEs as of September. These loans fall outside the scope of the GSEs’ mission, and the GSEs should also exit this space, according to AEI.
First-time homebuyer share declined 1.1 percentage points to 56.8% of purchase loans at the GSEs.
Meanwhile, home prices continue to appreciate but with greater speed at the lower end of the market.