Will Fannie Mae and Freddie Macs Low Down Payment Loans Cause Another Housing Collapse?

By Markets Fool.com

Fannie Mae and Freddie Mac both recently introduced programs to clearly define their lending standards and give homebuyers loans with as little as 3% down. This has prompted criticism from many people as to the safety and responsibility of this type of loan. After all, didn't the abundant availability of low down payment loans contribute to the housing collapse?

Continue Reading Below

While that's definitely been true in the past, things are a little different this time around. There is a right way and a wrong way to let people become homeowners without a lot of cash up front, and it looks like Fannie and Freddie are getting it right this time.

The new loan programs
Fannie Mae's 3% down loan program is available right now, and is limited to first-time homebuyers, which are defined as anyone who has not owned a home in the past three years. And even if a borrower does not meet the "first-time" standard, a conventional mortgage can be obtained with as little as 5% down.

Freddie Mac's 3% down program is called Home Possible Advantage, and will be available for settlement dates on or after March 23. Unlike Fannie Mae's program, the Home Possible Advantage loan program is not limited to first-time buyers.

Both programs limit the low down payment options to single-unit primary homes. So, investment properties, second homes, and properties such as duplexes are disqualified.

Continue Reading Below

What's different this time around?
Low down payments all by themselves aren't necessarily a bad thing, if used correctly. And Fannie and Freddie are taking steps to make sure things are different this time around.

One big difference is that the low down payment loans are limited to standard (up to 30-year) fixed-rate mortgages. The "exotic" loan options that used to be widely available with little or no money down, such as interest-only and negative amortization loans, are a thing of the past. And adjustable-rate loans are not eligible for this option, to prevent cash-strapped borrowers from finding themselves in over their heads when the interest rate jumps.

The level of documentation required is another big difference from the housing collapse. Prospective homebuyers are now expected to be able to document every detail of their financial situation. In fact, it's not uncommon for a mortgage application packet to consist of more than 100 pages of various income, employment, and financial documentation.

And finally, credit standards have relaxed in recent years but are still much higher than they ever were in the years leading up to the collapse. This is especially true for low down payment loans. According to Fannie Mae's loan-eligibility matrix, a borrower needs a minimum credit score of 680 in order to qualify for a down payment of less than 25%, which is significantly higher than the 620 required for loans with higher down payments.

In a nutshell, the difference is that even though you can once again buy a home with a low down payment, borrowers are being held to a higher standard in order to do so.

If you want to become a homeowner
If you're a renter and have been thinking of taking the plunge into homeownership, this could be the opportunity you were waiting for. In order to make the process go smoothly, there are a few things that you should do before applying for a loan.

For starters, you need to know where you stand credit-wise since the new loan programs require reasonably good credit. And, if your score is a little bit low, here are some suggestions on how to improve it. And, you should know exactly what to expect throughout the mortgage process and what lenders are looking for. You'll not only need credit, but enough income to justify the loan, a solid employment history, and the ability to document your savings and other financial assets.

It could be a good catalyst for housing in 2015
Along with the already popular FHA loan options, there are now plenty of ways for people to become homeowners without large amounts of money down. And the new programs prompted the FHA to significantly lower its mortgage insurance premiums in order to remain a competitive loan option.

These loans seem to me to be less likely to contribute to another housing collapse, and could actually do a lot of good for the housing market. First-time homebuyers currently make up a much lower share of the market than they have historically, and if these new programs are successful, an influx of first-time buyers could go a long way toward a healthy U.S. housing market.

The article Will Fannie Mae and Freddie Macs Low Down Payment Loans Cause Another Housing Collapse? originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.