GSE Reform: Is Buying a Home About to Get Way Harder?

GSE Reform

What the Heck is GSE Anyway?

GSE stands for “government-sponsored entity.” There are two specifically that matter to you: Fannie Mae and Freddie Mac. They don’t make mortgages, but between them, they purchase about 90 percent of the mortgages originated in the United States. Most of the rest are bought by private hedge funds managed by Wall Street investment banks. The remaining few are made by banks or credit unions and not sold to investors.

Fannie Mae and Freddie Mac (GSEs for short) buy large pools of mortgages and then sell bonds (promissory notes) to investors to raise more money to buy more loans. The principal invested in those bonds is guaranteed by the U.S. Government (that means you and me) and thus they are very low-risk investments. As a result, the yield investors need to earn is comparatively low, and the interest rate you pay on “conforming loans” is the lowest available.

Without the GSEs, home buyers would need to have larger down payments or pay huge premiums for their loans.

If you're wondering, "Conforming loans. What's that?" They are the loans intended to be pooled and sold to the GSEs. Non-conforming loans (sometimes called "jumbo loans") are those that are pooled and sold to other investors.

This system of buying pools of mortgages and selling bonds (which has worked for decades, BTW) has opened up access to mortgages to a larger number of home buyers at costs that are lower than they otherwise would be.

How Changes May Affect Your Home Buying Power

The current administration, and many members of Congress, want to sell the GSEs off to private investors. What will happen if the GSEs are sold off? Mortgage pools would no longer be guaranteed by taxpayers and the interest rates would jump about 0.500 percent (the difference between conforming and non-conforming loans).

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But that’s not all.

Underwriting guidelines would change dramatically.

Down payment. Conforming loans currently require only a minimum 3 percent down payment. Non-conforming loans typically require at least 20 percent, although some lenders offer as little as 10 percent down loans (at a very steep premium). Without the GSEs, home buyers would need to have larger down payments or pay huge premiums for their loans.

Debt-to-income ratio (DTI). Conforming loans are made with debt-to-income ratios up to 50 percent. Generally, non-conforming loans today go no higher than 43 percent. This difference alone would knock a significant number of home buyers out of the market, and the higher interest rates — which would make the debt-to-income ratios even higher — would eliminate even more buyers.

Minimum time in a job. Conforming guidelines require as little as one year of continuous employment in your line of work. Non-conforming guidelines require a minimum of two, and sometimes more. Self-employed people can use only one year of tax returns if a loan is to be sold to Freddie Mac. A minimum of two years will be required for non-conforming loans.

Income. All lenders restrict how much of your income can be used to qualify based on its source and expected continuance. These guidelines are generally much more stringent for non-conforming loans.

Student loan debt. When you go to apply for a home loan, the GSEs will allow you to use the minimum payment reported on your credit report when calculating monthly debt service (cash required to cover the repayment of interest and principal on your student loan). Many non-conforming lenders will impute a higher payment, particularly if your student loan repayment plan is an income-based one.

These are just some examples. There are dozens of arcane guidelines that, if non-conforming lenders do not adopt conforming standards, will drastically reduce the availability of mortgage financing.

Mortgages will still be available, and some believe that privately-owned hedge funds would find a way to ease guidelines to serve a market for which there is obvious demand. Common sense would say that easing guidelines would add risk, which would be reflected in the price.

For now, be aware that Fannie Mae and Freddie Mac — names you may have heard but thought very little about — actually matter to you a great deal.