Freddie Mac Finally Stops Buying Interest Only Mortgages

Freddie Mac announced, with little fanfare, that it will stop buying and securing mortgage loans that are based on interest only payments.  Freddie Mac is the second largest purchaser of home mortgages in the U.S. behind only Fannie Mae.  The press release provide by Freddie Mac announced that on or about September 1, 2010, the company will cease purchasing and securitizing interest only mortgages, including Freddie Mac Initial Interest fixed-rate and adjustable-rate mortgages.

Interest only mortgages became popular near the top of the housing boom, allowing buyers to purchase a larger home based on a lower mortgage payment provided by the interest only loan feature.  Interest only mortgage loans offered the borrowers the ability to make monthly payments that were only the interest portion of the debt and paid off none of the principal balance. 

The interest only option would be for a specified period after which time the loan would require interest and principal payments to retire the debt in full.  The interest only period frequently ran from five to ten years and then principal and interest payments would be scheduled on a fully amortizing basis for the remainder of the mortgage term.

Interest only options were available on both fixed rate mortgages and adjustable rate mortgages.  These loans allowed homeowners to make purchases during the period when homes were becoming less affordable.  The rational for these home loans is certainly suspect, the borrower is eventually going to be confronted with a larger more mortgage payment once the interest only period expires and for both the mortgage lender and home owner, there is no increase in equity during the interest only period unless housing prices continue to ratchet up.  The end result, these types of mortgage loans ended up performing worse than conventional, fully amortizing fixed rate loans. 

Fewer of these home loan have been produced in the past months since underwriting standards have become stricter.  Borrowers need to qualify for the loan based on a fully amortizing payment instead of just the interest only payment and they often require a larger down payment.

These changes may not put an end to these type of home loans forever but there are certainly fewer banks that make loans that do meet the qualifications established by Fannie Mae and Freddie Mac.  It is not likely that very many banks will be willing to take the risk of originating these loans without the security of Freddie Mac purchasing or securitizing the loans and leaving the possibly the bank will get stuck with a greater number of non-performing loans.