Credit backed by the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac is very tight. The average FICO score1 for a GSE-backed loan has increased from 710 in 2001, to 720 between 2004 and 2007, to over 760 as of the middle of 2012.  In addition, the GSEs are requiring loans to have lower loan-to-value ratios (LTVs) than in the past and are doing more vigorous risk-based pricing through their loan-level pricing adjustments. Moreover, both Fannie and Freddie have ceased buying loans with LTVs over 95 percent. As a result, the share of fully amortizing, 30-year full documentation GSE-backed loans with FICO scores greater than 750 and LTVs less than 80 percent has increased from 25 percent in 2001 to 30 percent in 2004 and 62 percent in mid-2012.

Lenders often blame the tight credit box and their reluctance to extend credit to any less-than-pristine borrower on uncertainty about the lender’s exposure to repurchase requests based on the representations and warranties they provide the GSEs. The lender’s concern is that if a loan defaults for any reason, the GSE will assert that the default was the result of improper underwriting and “put back”—meaning, require the lender to repurchase—the loan, instead of owning up to the credit guarantee the lender has paid for. One consequence of this uncertainty is that lenders have become excessively cautious, raising the minimum credit standards they require for making a loan well above what the GSEs require. A second consequence is that for the loans lenders do make, both the lenders and the GSEs believe they need to be compensated for default risk, so the borrowers in essence pay twice for the coverage. Shorter sunsets on rep and warrant obligations and a relaxation of the pay history requirement, coupled with more up-front due diligence, is perhaps the best way to create the certainty that lenders are looking for to expand credit. The FHFA is moving Fannie and Freddie in this direction with the January 1, 2013, introduction of a three-year sunset for loans that have perfect pay histories and a greater emphasis on up-front due diligence. We believe that as up-front due diligence efforts further ramp up, the sunset period could be reduced and the pay history restrictions relaxed, at minimal cost to the GSEs. If this is coupled with steps to clarify which parties bear which risk, it would reduce reps and warrants as a significant obstacle to expanding the credit box.