Fannie Mae, Freddie Mac bailout explainer

Jason Tyler is a senior vice president at Ariel Investments. What does the bailout mean to homeowners and buyers?

What does the Government's bailout of Fannie Mae and Freddie Mac mean?

As you know, Fannie Mae and Freddie Mac hold or guarantee approximately half of all mortgages in the US. Without them, your local bank or mortgage broker would not be able to offer nearly as many mortgages.

Because of expected mortgage losses, Fannie and Freddie were in a lot of trouble and needed to raise more capital. They weren't going to be able to raise enough capital, so the government came in and took them over.

Question: How will mortgage rates respond?

General sentiment is that mortgage rates will decrease. Last week the 30 yr. fixed mortgage rate was 6.26%. Today that rate is 5.88%. Predictions have been made that rates could go as low as 5.5%, but this is a very volatile market and no one really knows what will happen.

Follow-up Question: Will it be easier to get a mortgage?

Probably yes, but still only if you are qualified. The days of 105% financing and of receiving a mortgage by just telling your bank your income are over. Local banks and mortgage brokers are very aware of the qualifications required for a mortgage.

Question: Should you refinance?

That depends on your current rate and size of your mortgage. In 2006, the most recent year for which we have data, the average mortgage was $235,000. In the Chicago area it will cost approximately $2000 to refinance. Based off of the current 30 year fixed rate, it will take 21 months to cover the $2000 refinance cost.

Question: Is it a good time to buy or sell a house?

There will definitely be more stability in the housing market. Prices will remain low, but will hopefully stabilize. The past 12 months through July have seen home prices in the 20 largest cities fall by 17%, the fastest rate of decline since WWII.

Question: Will foreclosures slow?

Probably not for a while. The rate of foreclosures has increased to an annualized rate of 3 million homes, triple the normal level. Over the next 2 years almost $100 billion of sub-prime home loans made with adjustable rates will switch to fixed rates, raising borrowers monthly payments. The government's takeover of Fannie and Freddie will not stop these foreclosures from occurring, but it will provide the capital to guarantee the losses.

IF THERE IS TIME: Question: Now the big question, how much will this cost the average taxpayer?

Treasury Secretary Henry Paulson stated that this takeover was put in place to protect the taxpayer. The government will be repaid before the shareholders of Freddie and Fannie get a penny. The ultimate cost to the taxpayer depends on how quickly the housing market turns around. Estimates range anywhere from $25 billion to 100 times that number at $2.5 trillion.

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