New Borrowing Standards Could be Big Trouble

This Sunday, the meat-cleaver is dropping. The Boston Globe reported that Fannie’s “Desktop Underwriter” will be recalibrated to enforce the Federal Reserve’s new guidance on nontraditional mortgage risks.

Last September the Fed “demanded that any mortgage containing an interest-only feature be underwritten at the highest possible interest rate or subsequent amortizing payment, and that any mortgage containing a negative-amortizing feature be underwritten at the highest possible balance and interest-rate adjustment.” So what does this mean?

Two forms of hell will break loose… troubled borrowers trying to refi off their subprimes or other re-setting ARMs into interest-only loans to minimize payments will be out of luck. Add to that the rising foreclosure count. Also out of luck, the millions who planned defined ownership periods, safely using 7- or 10-year interest-only loans. Then the families with solid but unpredictable incomes (sales or seasonal, for example), for whom an option ARM was a godsend … the Fed and its pinched pals just made your lives riskier. It will take a little while longer to assess the harm to housing markets already desperate for demand.

In June we already saw a surge in inventory in the Seattle area and the number of sales dropping as complared to last year. With the new borrowing standards, we may see some price drops.