Fannie Set to Penalize Defaulters

Wall Street Journal
JUNE 24, 2010
By NICK TIMIRAOS

Fannie Mae said Wednesday it would "lock out" borrowers from getting a new loan for seven years if they default on a mortgage they could afford to pay.

The move represents the latest effort by the mortgage industry to prevent a new wave of losses that could result if more borrowers who can afford their monthly payments instead opt to "strategically" default on loans, because they owe far more than their homes are worth.

"Walking away from a mortgage is bad for borrowers and bad for communities, and our approach is meant to deter the disturbing trend toward strategic defaulting," said Terence Edwards, Fannie's executive vice president for credit portfolio management.

The government-owned mortgage-finance titan also said it planned to step up legal actions to pursue deficiency judgments in states that allow lenders to go after borrowers' other assets. In addition, Fannie said it would instruct its lender partners to monitor delinquent loans owned by Fannie, and recommend cases that warrant attention.

Fannie's move comes amid greater concern that it has become socially acceptable for borrowers to stop paying their loans, and that such a shift could exacerbate the housing bust. Those worries are particularly acute in Arizona, Nevada, Florida and other hard-hit housing markets where it could take years for borrowers to return to positive equity.

Nearly one in four homeowners with a mortgage is underwater, or owes more than their home is worth, according to CoreLogic, a real-estate data firm. A Morgan Stanley report estimated that around 12% of all mortgage defaults in February were strategic.

In 2008, Fannie revised to five years from four the period that borrowers with a foreclosure must wait before they are eligible for a new loan.

Under the new rules, the five-year waiting period is eliminated. Borrowers who can't document "extenuating circumstances" or show that they made an effort with their lender to avoid foreclosure will have to wait seven years to get a new loan; those who can demonstrate hardship or attempted a workout with their lender may have to wait only three years.

Its smaller sibling, Freddie Mac, also requires borrowers with a foreclosure to wait at least five years. Foreclosures can stay on a credit report for up to seven years.

Even as it steps up penalties, Fannie is preparing to reduce waiting periods for borrowers facing hardship who surrender their homes and avoid foreclosure. Under previously announced rules that take effect next month, Fannie will reduce waiting periods to two years for borrowers who agree to transfer their homes to the company through a "deed in lieu of foreclosure," or who complete short sales, where homes are sold for less than the amount owed.