Get ready for mortgages to become more expensive - and stay that way.

The Obama administration has released its recommendations for reforming housing markets and overhauling the government's role in backing mortgages. And virtually all of them involve pulling back the supports the government has traditionally provided to make home loans more affordable.

Even the 30-year fixed-rate mortgage, prepayable without penalty, which generations of homebuyers have come to regard as a near-birthright, could eventually be priced out of reach of many homebuyers and play a significantly reduced role in the housing market.

A gradual elimination of Fannie Mae and Freddie Mac

The key part of the proposals, released today in a report to Congress, is for gradually phasing out Fannie Mae and Freddie Mac, the two government-charted lenders that back the majority of U.S. residential mortgages, but which suffered massive losses in the collapse of the subprime mortgage market. What might replace them is not yet clear, although three options proposed in today's report all envision a far less active government role in supporting affordable home loans.

Those changes would begin almost immediately, by gradually eliminating the competitive advantages Fannie Mae and Freddie Mac have over private lenders, by requiring them to increase their pricing to a level even with the private market over the next few years.

In addition, the administration is also calling for reductions in the maximum loan amount for mortgages backed by the lenders, first by allowing a temporary increase in conforming loan limits to expire as scheduled in October, then seek further reductions later on. The maximum currently is nearly $730,000; it is set to fall back to $417,000 this fall, which would exclude a big chunk of potential borrower in certain markets.

Affordable mortgage support to be more limited

To be sure, the Obama administration is not backing completely away from government support for affordable mortgages. However, it envisions that such support should be targeted at low- and moderate-income homeowners with good credit, rather than broader mortgage affordability for the middle class in general.

"Going forward, the government's primary role should be limited to robust oversight and consumer protection, targeted assistance for low- and moderate-income homeowners and renters, and carefully designed support for market stability and crisis response," the report read.

"Although the government still has an important role to play in housing finance, private markets - subject to strong oversight and standards for consumer and investor protection - should be the primary source of mortgage credit and bear the burden for losses," another portion read.

The report proposes that the FHA return to its role as the targeted provider of mortgage credit for low- and moderate-income borrowers and first-time homebuyers. It envisions the FHA accounting for about 10-15 percent of the mortgage market, its historical norm, down from around 30 percent currently, with measures in place to prevent it from claiming a larger share as Fannie Mae and Freddie Mac are wound down.

Three options suggested

Of the three proposals for replacing Fannie and Freddie, only one envisions a government role similar to that of the two lenders, although significantly scaled back from what they do. All envision higher borrowing costs for most mortgage consumers, although with greatly reduced taxpayer exposure to potential losses.

The first proposal suggests an almost fully privatized mortgage market, with government involvement limited to a few narrowly targeted types of loans, such as FHA, VA and USDA mortgages. The second proposal closely resembles the first, except with a limited government guarantee that would kick in to ensure access to credit during times of economic crisis.

In both, the private sector would absorb virtually all the risk involved. However, the report notes that mortgage costs would likely rise for the majority of borrowers, and that traditional 30-year fixed-rate mortgages could be priced out of reach for many.

The third option would involve a broad government insurance for mortgages that conform to certain underwriting standards, much as presently occurs with Fannie Mae and Freddie Mac. However, it would be a secondary insurance that would only pay out to investors after a primary, private guarantor was wiped out. This option is seen as likely offering the lowest-cost mortgages of the three, including availability of prepayable, 30-year fixed-rate loans, although at higher costs than are currently available.

Congress will undoubtedly have its own say as to what the eventual replacement or overhaul of Fannie Mae and Freddie Mac will look like, but today's proposals likely sets forth what the parameters of the debate will be.

Published on February 11, 2011