Freddie Mac Abandons Ship on Interest-Only Loans

Freddie Mac said on Friday that it would stop buying and securitizing interest-only loans in September because those mortgages have performed so poorly.

Interest-only mortgages allow borrowers to make payments on interest for an initial period, usually between three and 10 years, before requiring principal and interest payments for the remainder of the term. An adjustable-rate variety of those loans, called “hybrid ARMs,” feature a fixed-rate during the interest-only period that resets annually to a market benchmark when the loan begins amortizing.

During the housing boom, those interest-only ARMs became increasingly popular because they allowed homeowners to make purchases even as homes became less affordable. “It normally allows you to buy more house than you would be able to afford,” says Guy Cecala, publisher of Inside Mortgage Finance.

After the private mortgage market collapsed in late 2007, Freddie and its larger rival, Fannie Mae, remained the only buyers of interest-only mortgages. Fannie has been more active in buying interest-only loans, and purchased $9 billion last year, compared to just $2.1 billion in purchases by Freddie Mac, according to Inside Mortgage Finance. Freddie bought just $413 million during the fourth quarter.

A Freddie spokesman said the company was exiting the interest-only market as a result of “continuing poor performance of these products” and as a result of the company’s efforts “to promote responsible lending and sustainable homeownership.”

Freddie Mac guaranteed $130 billion in interest-only loans at the end of 2009, or around 7% of all loans it backs. While around 4% of all loans guaranteed by Freddie were 90 days or more delinquent at year end, the rate for interest-only loans stood at 17.6%.

Freddie didn’t offer an interest-only loan option until 2004, and many of its outstanding loans were made at the top of the housing market. Nearly 72% of Freddie’s outstanding interest-only loans were made in 2006 and 2007, at the peak of the housing bubble. The average loan-to-home value ratio on outstanding interest-only loans is very high, at around 106%.
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