For more help with credit issues, go to Credit Connection, where you can: • Check your credit history

• Consolidate your debt The agencies are expanding their turf - and their market share - by guaranteeing not only "A" quality loans, but also subprime loans classified as A-minus and B.

"Generally, using our technology, we can understand the credit risk of borrowers that have typically been outside our reach," said Pam Johnson, vice president of single-family business at Fannie Mae. She stressed that new analytical systems can better assess credit risk than in the past.

The agencies guarantee loans that meet their criteria, allowing mortgage lenders to charge lower interest rates. They also buy mortgages for their own portfolios, which helps take supply out of the market and keep mortgage rates low in the secondary market.

While the latest steps by the agencies are welcoming news for home buyers, they are raising some concerns among players in the mortgage-backed securities market. Subprime loans with different characteristics are being included in mortgage-backed securitizations, affecting the duration of the bonds and causing their yields to fluctuate in odd ways.

Fannie Mae last week launched what it calls Timely Payment Rewards. Borrowers who qualify for this program will be able to finance their home at a mortgage rate as much as 2% lower than what credit-impaired borrowers typically pay, said Frank Demarais, vice president of product development at the agency. And if borrowers make their payments on time for two years, they will receive a 1% rate reduction.

Fannie boasts that the new program, in one example, could allow a borrower with slightly impaired credit to obtain a 30-year fixed-rate $100,000 mortgage at an initial interest rate of 9.5%. After two years without delinquency, the rate would be reduced to 8.5%. This compares to an average interest rate of 11.5% for a loan originated in the subprime market and 7.8% for a traditional conforming, or A, mortgage.

Subprime Market Could Benefit

The agencies over the last 18 months have launched various products targeting an expanded borrower universe. Last year, they began programs aimed at "Alt-A" borrowers, who have good credit history but don't qualify for A product, usually because of missing documentation.

This year the agencies expanded their guarantee into the A-minus sector, which encompasses loans that have higher loan-to-value ratios or other qualities that are considered riskier.

Both agencies have been buying subprime mortgages for their portfolios.

Fannie Mae estimates that a roughly $35 billion segment of the $150 billion per year subprime market could qualify as expanded collateral under its new programs. That amounts to about a quarter of the subprime, or home equity, market.

Fannie and Freddie say they are offering their names and guarantees to these new groups of borrowers to expand the availability and affordability of home financing.

The agencies, meanwhile, benefit from higher returns they receive when they invest in this expanded spectrum of product.

"It's a good investment for the agencies," said Michael Hoeh, senior portfolio manager at Dreyfus Corp. "Credit losses are at an all-time low and they tend to keep high reserves against those losses," he said.

The agency guarantees also expand the universe of investors that will invest in alternative mortgage products.

"A lot of investors won't touch anything without the Fannie or Freddie label on it," said Jeff Ho, senior vice president of mortgage strategy at PaineWebber.

The Bond Market Association allows up to 10% of the new "expanded collateral" to be included in the agencies' TBA, or to-be-announced pools, which make up the bulk of the mortgage-backed market.

Worries About Expanded Collateral

But investors and analysts raise some concerns about the expansion of collateral to include subprime loans, which prepay at different speeds than traditional conforming product.

Alt-A and subprime loans have different credit profiles than traditional conforming product and can skew the weighted average coupon of a pool because they carry higher rates, said Amitabh Arora, vice president of mortgage research at Lehman Brothers.

When interest rates are lower than the weighted average coupon of a mortgage pool, it can be assumed that a number of loans in the pool will be prepaid because borrowers can refinance the loans at lower rates. However, subprime borrowers would have to pay a premium over the prevailing mortgage rate and would be less likely to prepay.

"We're not seeing those higher-coupon loans prepaying as quickly as models would predict," Dreyfus' Hoeh said, adding that most models assume 100% high-quality loans in TBA pools.

"Initially, Alt-A and subprime loans will be slower to refinance," agreed Arora. "We are already seeing that." He adds that he would like information on the guarantee fee that the agencies charge on each loan because those fees will have prepayment implications.

Market experts say it is important that investors know the percentage of the alternative products in TBAs in order to model them more accurately.

A Freddie spokesman says that the agency tries to keep coupons in any given pool within a tight range to allow investors and analysts to better model prepayments.

But should the credit environment turn and residential defaults rise, the Alt-A and subprime loans will be the first to default, Hoeh warned.