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Do residential rental properties with one to four units and second-home mortgages carry more risk? Apparently so says the U.S. Treasury Department. Such loans underwritten by Fannie Mae and Freddie Mac will end up costing you more under restrictions quietly announced earlier this year. What is the new rule? How will the new rule impact second home buyers and investment residential properties in Colorado’s ski towns? 4 changes to watch for.
What was in the new Fannie/Freddie rule
Fannie Mae is tightening the underwriting criteria for second homes and investment properties, the government sponsored entity said in a letter to sellers on Wednesday.
“Recent amendments to our senior preferred stock purchase agreement with Treasury impose additional risk criteria on the loans we acquire,” the GSE said in a letter. “One of those restrictions is a 7% limit on our acquisition of single-family mortgage loans secured by second home and investment properties.”
The new restrictions say that no more than 7% of the mortgages that lenders sell to Fannie or Freddie can be tied to second homes or investment properties. The cap is based on the overall dollar volume of loans purchased by Fannie and Freddie, though the companies are implementing the restrictions on lenders that sell them loans.
Why does this new rule change the mortgage market:
By limiting the percentage of loans sold to the government sponsored entities (GSEs Fannie Mae and Freddie Mac) the mortgage market for these loans will be transformed. Remember the two GSEs are the largest buyers of mortgages. They purchase loans from banks, mortgage brokers, etc.. and take on the risk of the loan as long as it meets their requirements. They then package and sell these loans to various buyers through bonds. As the GSEs limit loan purchases, banks will be forced to portfolio or sell these loans to other buyers at higher costs and more risk to the lender.
Four changes to investment and second home buyers from the new rule
- Banks become more conservative as they will have to portfolio or sell to other buyers: In a nutshell, look for lenders to become considerably more conservative on their underwriting of second home/investment property loans
- Higher interest rates: Without the government guarantee for purchase, lenders will raise their rates to compensate for the increased risk. I could see rates trending similar to Jumbo loans that are ½% or more than a traditional conventional loan.
- Larger down payments: with increased riskis to the lender, the easiest way to mitigate risk will be to increase down payments. For example, in the past you could get a loan with 10-15% down, under the new requirements the down payment will likely be 20-30%.
- Banks will make less loans to second homeowners and investment property buyers: many banks will decide that the increased risk of having to hold these mortgages is not worth it and they will pull back from this market except for the highest quality loans. This is similar to the jumbo market.
How will the new Fannie/Freddie rul impact Real Estate purchases in Colorado’s ski towns
Colorado is unique in that in many ski towns, the median home price is well above the conforming loan limits. This means that in resort communities 90% of the single-family homes will have no impact from this rule. For example, in Breckenridge, the average home price is 1.9m and the max conforming limit is 825k so there are very few if any conventional loans sold to Fannie/Freddie on single family homes
Condos on the other hand will have a much greater impact. The median sales price in Summit county for condo/townhome is 455k so many of these purchasers are using a conventional mortgage. With the new Fannie/Freddie rules interest rates will rise for new buyers.
Unfortunately, affordability is not necessarily what is driving the resort markets it is demand, lack of inventory, and extremely high building costs. These factors will far outweigh any impact from a rise in rates due to Fannie/Freddie changes.
What markets will the Fannie/Freddie changes impact the most in Colorado?
As highlighted above, the resort markets will have little impact from the changes so where will Colorado real estate be impacted the most? Tertiary markets will slow down from the Fannie/Freddie changes. An example would be a market like Fairplay, CO that is more cost effective than Breckenridge as people can buy there to come into Breckenridge at a lower price point. In Fairplay, second homes are much less likely to be bought in cash and most loans are conforming. The new Fannie/Freddie rules should begin to slow these markets.
The resort communities/ski towns throughout Colorado are having a historic run with prices reaching record levels and inventory falling to record lows. I’ve been wondering how the resort markets slow down. The new Fannie/Freddie rules will have no impact on the ski towns throughout Colorado as other factors like demand, lack of inventory, and high building costs will easily overcome any increase in rates due to this rule. On the other hand, more cost-effective markets outside of these resort areas like Fairplay will have a much bigger impact from the changes. I’ll keep wondering when/how the resort markets slow down. What other Colorado markets do you think will be most impacted by these changes?
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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