Freddie Mac Guidelines: Prohibited Practices and Restrictions

What These Prohibited Practices Mean for Your Mortgage

When you apply for a mortgage that will be sold to Fannie Mae, certain practices are completely off-limits. These restrictions exist to protect you from predatory lending and excessive fees that could make homeownership more expensive or risky.

The three main prohibited practices involve credit insurance products, private transfer fees, and mandatory arbitration clauses. Each restriction serves a specific purpose in keeping mortgage lending fair and transparent.

Credit Insurance Restrictions

Fannie Mae prohibits mortgages where borrowers purchased prepaid single-premium credit insurance policies. This includes credit life insurance, credit disability insurance, credit unemployment insurance, or credit property insurance where you pay the entire premium upfront.

Say you're buying a $300,000 home and the lender offers you a credit life insurance policy for $3,000 that you can either pay at closing or add to your loan amount. If you take this deal, Fannie Mae cannot purchase your mortgage. The lender would need to keep your loan in their portfolio or sell it elsewhere.

The restriction only applies to prepaid single-premium policies. You can still purchase credit insurance where you pay monthly premiums or other regular payments. You can also buy standard hazard insurance, flood insurance, or mortgage insurance with upfront premiums.

This rule protects borrowers because prepaid credit insurance is often overpriced and provides limited value. The upfront cost can add thousands to your closing costs or loan balance, and the coverage typically ends when you pay off or refinance the mortgage.

Private Transfer Fee Covenants

Properties encumbered by private transfer fee covenants created after February 8, 2011 are ineligible for Fannie Mae financing. A private transfer fee covenant is a legal agreement that requires future owners to pay a fee every time the property is sold.

These covenants typically require payment of a percentage of the sale price or a flat fee to a third party who has no connection to the property. The fee might go to the original developer, a homeowners association, or an investment company.

Your lender must verify that the property is free from prohibited transfer fee covenants before closing. This verification typically happens during the title search and examination process.

There is one exception for shared equity loans that meet specific Duty to Serve program criteria and have note dates on or after July 1, 2023. These specialized loan programs help moderate-income borrowers access homeownership through shared appreciation arrangements.

Mandatory Arbitration Clause Restrictions

Your mortgage documents cannot include mandatory arbitration clauses. These clauses would force you to resolve any disputes about your mortgage through private arbitration rather than in court.

Mandatory arbitration clauses might appear in the promissory note, note addendum, deed of trust, mortgage, or any rider attached to these documents. Fannie Mae's standard uniform instruments do not include arbitration clauses, and lenders cannot add them.

This restriction preserves your right to take legal action in court if problems arise with your mortgage. Arbitration can limit your ability to recover damages and often favors lenders over borrowers.

Some borrowers confuse this with voluntary arbitration programs that lenders might offer after a dispute arises. You can still choose arbitration if both parties agree, but the lender cannot require it upfront as a condition of the loan.

Required Documentation and Verification

Your lender must document compliance with these restrictions before your loan can be sold to Fannie Mae. For credit insurance, the lender reviews your closing disclosure and loan documents to confirm no prohibited insurance products were included.

For transfer fee covenants, the title company or attorney conducting your closing will search public records and provide a title commitment or title insurance policy. This documentation must show the property is free from prohibited covenants.

The lender also reviews all mortgage documents to ensure no mandatory arbitration clauses were included. This happens during the loan document preparation and quality control review process.

If your lender purchased your mortgage from another lender, they must obtain representations and warranties confirming the property has no prohibited transfer fee covenants. This creates a chain of accountability back to the original lender.

Why These Rules Exist

These restrictions protect the mortgage market and individual borrowers from practices that can make homeownership more expensive or risky. Prepaid credit insurance often provides poor value and adds unnecessary costs to mortgages.

Private transfer fee covenants can make properties harder to sell and reduce their value over time. Future buyers might avoid properties with these fees, limiting your options when you want to sell or refinance.

Mandatory arbitration clauses can prevent borrowers from seeking full legal remedies if lenders violate mortgage terms or engage in predatory practices. Preserving court access maintains important consumer protections.

Common Issues and Complications

Problems most often arise with transfer fee covenants in newer developments or planned communities. Some developers created these covenants before the 2011 prohibition, making properties eligible for Fannie Mae financing. Others created them after the cutoff date, making properties ineligible.

Your title company might need extra time to research complex covenant structures or determine when specific covenants were created. This can delay closing if the research reveals prohibited covenants that require resolution.

Credit insurance issues typically surface during loan document review. If prohibited insurance was included, the lender must remove it and adjust your closing costs or loan amount accordingly.

Some lenders try to work around arbitration restrictions by including clauses in separate agreements or disclosures. These attempts violate Fannie Mae guidelines and can make your mortgage ineligible for purchase.

References

For the official guidelines, see 4202.3: Prohibited practices and restrictions in the Fannie Mae Selling Guide.