WASHINGTON -- Freddie Mac, worried about declining credit quality, has tightened its rules on balloon mortgages. It also clamped down further on adjustable-rate loans.

Adjusting the Adjustables

Freddie Mac is changing its rules on some ARMs:

* It has doubled its down payment requirement to 20% from 10% on five-year balloons.

* It is requiring borrowers to qualify at the second-year rate under some circumstances.

* It is cutting the maximum loan to value on cash-out refis to 70% from 75%.

The agency has announced that five-year balloon mortgages it buys must have a minimum loan-to-value ratio of 80% instead of 90%. For the borrower, this doubles the down payment requirement to 20% from 10%.

The principal on a five-year balloon mortgage must be repaid in a lump sum in five years, so borrowers typically roll over the outstanding amount into another kind of loan. Balloons usually carry the option to convert to an adjustable rate.

But in a Nov. 30 letter to lenders, Freddie Mac said it has found that such loans were particularly susceptible to regional economic downturns. "This weaker delinquency performance may be compounded in markets where property values may not support a refinance and borrowers may not be able to afford the reset terms," the letter said.

Previously, Freddie -- formally the Federal Home Loan Mortgage Corp. -- increased the mortgage insurance requirements on loans with low down payments as loan-to-value ratios on its loans dropped sharply. The Federal National Mortgage Association, or Fannie Mae, followed with tighter insurance rules of its own.

Though the national delinquency rate fell to a 21-year low in the third quarter, economists are widely predicting increases as many refinanced mortgages go into their high-danger periods.

Freddie has also instructed lenders to qualify ARM borrowers at the fully indexed rate if:

* Their ARM loans could go up by 2% at the end of the first year.

* The loans have maturities of greater than 15 years.

* The loans have loan-to-value ratios of greater than 70%.

The agency said the change reflects "the increased risk" of initial "teaser" rates on ARMs. The rules match those put into place by Fannie Mae earlier this year.

A Fannie Mae spokesman said the changes by Freddie Mac would make it easier for lenders to originate and sell ARMs to the secondary market very similar."

Finally, Freddie Mac will require that refinancing ARM borrowers who take cash out of their mortgages maintain an LTV ratio of at least 70%. Under the old rules, borrowers could let their ratio slide to 75%.

"Freddie Mac has observed a deterioration in the creditworthiness of borrowers who selected cash-out refinances for all mortgage product types," the letter said.

"This change results from the increased complexities caused by combing a cash-out refinance with an ARM."

Fannie Mae continues to allow borrowers to cash out and


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