Harney: Freddie Mac pulls plug on low down payment loans

Freddie Mac did not provide a specific reason for its abrupt change, but stipulated that lenders providing gifts or grants to borrowers should not charge higher interest rates or fees to recoup their investments. Industry sources told me that some lenders were charging significantly higher rates and other compensation under Freddie’s popular low down payment program, and that borrowers weren’t always aware that the seemingly magnanimous gifts from the lender were being financed by themselves through higher monthly payments over time.

Known as “premium pricing,” the practice was not prohibited by Freddie previously but now is banned. Industry sources also said that Freddie’s policy of allowing premium pricing was at odds with the preferences of its government regulator, the Federal Housing Finance Agency, which had expressed concerns over possible consumer misunderstanding and abuses.

Here’s a hypothetical example of how the premium pricing worked in some 1 percent down programs. It was provided by Judy Zucker, vice president of FM Home Loans LLC of New York. A lender might charge an interest rate of 4.125 percent for standard 3 percent down loans but would hike that to 4.75 percent for a mortgage with a 1 percent down payment and a 2 percent gift.

Zucker, whose firm has not offered super-low down payment loans with gifts, said on a $350,000 home purchase the premium pricing would add $162 a month to a borrower’s payments — potentially for 30 years.

“Personally,” Zucker, wrote in an email, “I feel it’s not necessarily in the best interests of the client to take these loans.” That’s especially the case if the pros, cons and costs of the loan are not properly explained by the loan officer.

Freddie Mac’s policy switch won’t mean that very low down payment mortgages will disappear from the marketplace. Fannie Mae, Freddie’s larger competitor, continues to offer these loans through its network of participating lenders. Unlike Freddie, Fannie’s rules have prohibited premium pricing and have required lenders to ensure that their “gifts” are truly gifts, not financed by higher charges to the borrower tucked away somewhere in the transaction.

Mat Ishbia, president and CEO of United Wholesale Mortgage, a large national lender and early proponent of super-low down payment loans, told me his company’s approach has been to provide “true gifts” — up to a $5,000 maximum — from the start.

The interest rate and fees on a standard 3 percent down payment mortgage from his company, according to Ishbia, are the “exact same” as on a 1 percent down loan that uses gift contribution. Ishbia said his firm has funded ” thousands” of super-low down payment loans, and high demand has forced him to double the initial $10 million set aside for gifts to $20 million. Ishbia said the company has sold the loans to both Freddie Mac and Fannie Mae.

So what does all this mean to you if you’ve been planning to buy a home with a tiny down payment? To begin with, be aware of the premium pricing issue: None of these loans involving “gifts” should charge you more than a standard 3 percent down plan. Ask about it.

Also be aware that 3 percent and 1 percent loans come with their own special requirements: income limits and sometimes higher credit score minimums. If you’ve got sub-par credit, don’t expect any gifts from the lender.

Kenneth R. Harney of the Washington Post Writers Group is a past member of the Federal Reserve Board’s Consumer Advisory Council and is currently on the board of directors of the National Association of Real Estate Editors. Reach him at KenHarney@earthlink.net.