Freddie Mac: Final Nail in the Coffin of Interest-Only Mortgages?

Freddie Mac (FRE) announced today that it would no longer purchase or securitize interest-only loans, in a move that just makes you wonder, what took so long? The government-sponsored entity is the second largest purchaser of U.S. residential mortgages and has dealt with very underachieving performance of these interest only (IO) mortgages. At last count, Freddie had $130 billion in unpaid principal on these IO loans, or 7% of their overall portfolio. Of those loans, 18% of them are considered seriously delinquent or more than 90 days past due. Only at a government sponsored “zombie” would it take $23.4 billion in delinquencies to discover that the business should stop exposing itself to the same risks again and again.

For those unfamiliar with interest-only loans, in general it is a mortgage that the borrower agrees to only pay the interest on the debt for a set period of time, normally five or ten years. At the end of the interest-only period, the mortgage payment “balloons” because the borrower must begin paying off the principal as well as the interest. Many times, the purpose of such a loan is for a person who wants to buy a house and believes their future income will increase to cover the payments that otherwise they would not be able to afford. It is easy to understand why these loans get a lot of the blame for inflating the housing bubble. Obviously, the problem arises when the borrower’s income does not meet their expectations, or as is all too common these days, it disappears entirely. Furthermore, this type of loan can be particularly destructive when the housing market falls because there has been no dent made in the principal amount, so a home owner can be “underwater” more quickly.