Fannie Mae and Freddie Macs automated underwriting systems have quietly begun accepting more loans on the lower end of the credit spectrum, according to brokers and lenders nationwide.
Approved loans with Fair, Isaac scores of 580 to 620 are now commonplace, some brokers and lenders said. One lender said an accepted loan with a 540 score recently crossed his desk.
Predictably, subprime lenders, like many in the financial services sector, contend that the GSEs are unfair competitors because they get government advantages.
Whether or not that is the case, the idea that Fannie and Freddie would dip their toes further into subprime lending has lenders concerned that their margins will shrink and their profits erode. They also fear they will lose business as prime lenders snap up their loans by offering better rates.
They are absolutely going to eat the subprime market alive, said Tom Jarboe, an Irwin Mortgage Corp. branch manager in Walnut, Calif. They are picking the cream of the crop of subprime.
An executive at a major subprime lender said as the GSEs get further into the nonconforming business, they put a squeeze on margins, making it more difficult for people to survive.
As the Fannie and Freddie underwriting systems accept loans with lower scores, subprime lenders will have no choice but to go further and accept even higher-risk loans, this official added.
When Fannies Desktop Underwriter and Freddies Loan Prospector achieved widespread use, the lowest credit score the systems would accept was 720, several sources said. But this threshold began to fall in 1999 and appears to be continuing its descent, the sources said. Charles Bachman, owner of Tri-County Mortgage Co. in Larchmont, N.Y., said the number of subprime borrowers he has been able to put into conventional loans has increased 50%.
William D Dallas, chief executive officer of 1st Franklin Financial, a San Jose, Calif., subprime lender, said these types of loans should not fit Fannie and Freddie guidelines. The GSEs have come into our category for a reason, he added.
It is unclear whether Fannie and Freddie are directly soliciting the lower Fair, Isaac scores. Several sources said the GSEs do not tell lenders what scores are acceptable, so it is up to them to use trial and error to determine what loan characteristics the automated underwriting systems will tolerate.
Further, several sources said glitches in the underwriting systems themselves are responsible for the acceptance of low scores. According to these sources, many mortgage brokers have figured out how to manipulate the systems to push through loans that in the past would have been rejected.
Nonetheless, Dean Memsick, a broker at Platinum Mortgage Group Inc. in Omaha, said he was told by Republic Mortgage Insurance Co., the company through which Platinum gains access to Desktop Underwriter, that he could accept loans with a 580 Fair, Isaac score. Loans with scores from 580 to 600 are generally classified as B-grade credits, he said.
Mercy Jimenez, Fannies senior vice president of single-family marketing, said it does not use Fair, Isaac scores in a final determining way to accept or reject loans.
No one, single variable in and of itself drives a Desktop Underwriter decision, she said. Its not only looking at credit history but weighing variables like equity-to-loan ratios, debt-to-income ratios, the purpose of loan, and what kind of property is involved.
Moreover, officials from the two GSEs candidly acknowledge they have liberalized their automated underwriting systems guidelines to widen the field of borrowers they can accept for loans.
Under highly publicized subprime programs, Fannie and Freddie have been buying loans made to borrowers with slightly impaired credit for more than a year. Under the programs, borrowers get better rates than they would for a typical subprime loan, and if payments are made on time for two years, the interest rate is reduced.
If a borrower is Fannie Mae-eligible and deserves a lower cost on a mortgage as defined by their credit quality, he or she should get that, Ms. Jimenez said. In fact, Fannie has boosted its program 10% to 20% since January after an 18-month pilot run, she said.
The program, which now includes 100 lenders, bought $1.6 billion of loans last year.
Freddie officials say the company buys its subprime loans in two ways. First, it bought $9.5 billion of Alt-A and A-minus loans through its automated underwriting system last year, officials said.
But Freddie also says it buys higher-risk loans through subprime lenders such as Option One Mortgage in Irvine, Calif. Because of the higher risk, the lender is required to take the first loss position on the loan and to service it. Freddie bought $8 billion of loans through this program last year.
Yet many subprime lenders say that by offering conventional loan rates to subprime borrowers, Fannie and Freddie are not adequately pricing these borrowers risk.
They are applying A-market loan-to-values to very low Fico score credit, said Charles Coudriet of Saxon Mortgage in Glen Allen, Va. Theyre taking on a lot of risk that eventually could be laid at the foot of the taxpayers without proper assessment. However, many analysts who follow Fannie Mae and Freddie Mac defend their policies.
J.T. Marcell, a broker at Better Mortgage Brokers Inc. of Upland, Calif., and president of the California Association of Mortgage Brokers, said that by accepting lower-quality loans, Fannie and Freddie are improving the market for consumers, many of whom will now get better rates.
Yet subprime lenders remain deeply concerned.
Fannie is taking the spreads out of the business, said a subprime lender who asked to remain anonymous. If youre a New Century, youre toast.
Mr. Dallas of 1st Franklin Financial said the GSEs have opened the spigot on subprime originations. His message to Fannie chairman Franklin Raines is: I told you so, I knew you would, and you better tell your shareholders youre into subprime. I dont think a lot of times they know.