December 2, 2022

Fannie and Freddie – The New Subprime Lenders

Fannie and Freddie Impose Huge Fees On Borrowers

Freddie Mac last week announced additional fees for condo owners who refinance, effective April 1, 2009.  The fee mirrors a similar charge imposed by Fannie Mae last year.  Both Fannie and Freddie now assess a wide variety of fees to borrowers based on loan to value, credit and type of loan.  The fees are euphemistically referred to as “Postsettlement Delivery Fees for Mortgages with Special Attributes”. Translation – we need the money and are now charging huge fees to reflect lending risks that we never recognized prior to the housing crash.

Many borrowers are finding out that the Fannie and Freddie fees are resulting in mortgage rates far higher than the rates they see advertised.  See All Time Low Rates For A++ Borrowers Only.   The fees imposed are too large to be absorbed by the lending institutions that sell their loans to Fannie and Freddie.  Therefore the fees must be passed on to the customer in the form of closing costs and/or a much higher interest rate. The total fees imposed by the agency lenders are cumulative for each special attribute. The end result is that the fees and rates are so high that most borrowers are unable to refinance.

Here is an example of the fees that Fannie and Freddie would charge on a routine mortgage refinance with the following “special attributes”.   The borrower is attempting to refinance at 80% loan to value, has a 675 FICO score and needs to take cash out.    This is a routine type of refinance and the credit score of 675 is considered good.  The borrower is applying for the prevailing rate of 5.5%. Three years ago, this borrower would easily have qualified under a conforming Fannie or Freddie loan with a minimum of agency fees.  The same borrower today, if approved, would be facing very steep fees as follows in a $250,000 loan example.

Delivery Fees Effective April 1, 2009 Based on 80% Loan to Value

1. 675 FICO score fee 2.50%
2. Cash out fee 1.50%
3. If the property is a  Condo add additional fee .75%

The total fees imposed by Fannie or Freddie on this example loan would total 4.75% of the $250,000 loan or $11,875. In addition, there are various lender and legal fees involved in a refinance that could easily total another $2,000.   These Fannie and Freddie fees make the defunct sub prime lenders look like good guys.

Rates Are Low – Don’t Bother Applying

In real life, here’s what would happen. The borrower refuses to pay $11,875 in fees to get 5.5%.  The lender could not provide that rate in any event since the total of fees involved are so high that they would violate predatory lending rules. The rate cannot be raised enough to absorb all of these fees based on current pricing structures.  The best this customer could get would be a rate of around 7.25 and agency fees of $7,000, plus regular closing costs.  Several years ago, this customer could have gotten a lower fixed rate with much lower fees from a sub prime lender.

For a borrower to get the “low rates available” today, you usually need to show up with a credit score of 740 and a loan to value of 70% or less. Most borrowers who need to refinance today do not possess this loan profile.  While the Fed strives to lower mortgage rates, Fannie and Freddie are effectively telling all but the highest quality borrower to get lost by pricing them out of the market.  Compounding this ridiculous situation is that the Federal Housing Administration (FHA)  does not charge many of these fees, even at higher loan to values and lower credit scores.

By the way, did I mention that the Government has effectively nationalized the mortgage industry?

All Time Low Mortgage Rates For A++ Borrowers Only, Fed’s Efforts Futile

As discussed on December 31, 2008 many homeowners attempting to lower their mortgage rate apply for a refinance, only to discover that they do not qualify for the “low advertised rate” (Few May Benefit From Lower Mortgage Rates).

Unless a borrower has perfect credit (at least a 720 FICO score), adequate income (debt ratio of 32% or less) and substantial equity in the home (loan to value of 75% or less), the rate will be higher due to adders.  Adders are fees imposed by Fannie and Freddie if the applicant does not fit into the little box of a perfect borrower.  Adders are imposed for higher loan to value, lower credit scores and cash out refinances.  The adders can easily amount to 2% of the loan amount, or $2,000 on a $100,000 loan.   If a borrower is applying for cash out with a FICO score below 680 many lenders will turn the loan down.

This is the reality of the mortgage market today.  Many borrowers applying for a refinance with visions of a 4.875% rate and a payment reduction are finding out that they do not qualify.   There is much in the news about the “mortgage refinance boom”.   Expect to see stories in a month or two about how few borrowers actually benefited from the lower rates.

The stories of how few borrowers actually benefit from the lower rates did not take long to be noticed.

Rates Fall, But Refinancings Are Limited – Wall Street Journal

Interest rates on fixed-rate mortgage loans for prime borrowers have fallen to below 5%, the lowest level since the 1950s, triggering a wave of mortgage-loan inquiries from borrowers eager to refinance. But lenders and mortgage companies say that as many as half of the people who want to refinance can’t meet the credit hurdles and won’t get approved.

Only about a third of U.S. mortgage debt outstanding is likely to qualify for refinancing, said Doug Duncan, chief economist of Fannie Mae. Nearly 70% of borrowers don’t make the cut, he said, most often because their credit isn’t good enough or they don’t have sufficient home equity. A significant number of homeowners owe more than the current value of their homes, a situation sometimes known as being “under water.” Others can’t profitably refinance, often because they hold jumbo mortgages, those above the $625,000 limit for loans that can be bought or guaranteed by Fannie Mae or Freddie Mac in the highest-cost areas.

Since December 31st when I warned that only the best borrowers would be getting approved, rates have continued to decline.  The best borrower can now obtain a par rate of 4.5%.  On an after tax basis, mortgage money  now costs around 3%.  (I remember when savings bonds used to pay 6%.)  The good news is that for those who handled their financial affairs properly, the reward is the lowest mortgage rate ever.  The bad news is that your home has crashed in value, your stock retirement account is 40% lower and your hard earned savings yield zero interest if you prefer to invest in government treasuries.   On my scoreboard, we are all losers here, regardless of lower mortgage rates.

Borrowers Who Take Cash Out On Refinances Are Not Spending The Money

Mortgage refinances being approved show a pronounced borrower preference for frugality.  Many borrowers refinancing are doing so only to lower their payments, not to take cash out.  Those taking cash are mostly paying off other high rate debt or putting the money into savings.   This is not surprising since an A+ borrower does not happen by accident – they are frugal by nature and do not run up large amount of debt for frivolous reasons.  Those most inclined to maximize cash out and immediately spend the proceeds are largely no longer qualified for loan approval, either because of income, credit or equity restrictions.

Fed’s Efforts Futile

The Federal Reserve has spent hundreds of billions of taxpayers’ dollars buying mortgage backed securities to artificially suppress mortgage rates.  If the Fed’s intention was to spur more debt and spending by consumers, they have largely wasted their time and our money.   See Fed’s Asset Purchases Continue To Expand.

30 Year Mortgage Rates At 4.5% – Is 3.5% Possible?

How Low Can Mortgage Rates Get?

According to Freddie Mac, the average 30 year fixed rate mortgage dropped for the 10th consecutive week to a new low of 5.01%.   This is the lowest rate reported by Freddie Mac since they began keeping track in 1971.

Rates have moved sharply lower over the past two weeks to all time lows despite the fact that the 10 year treasury bond did not move to new lows.  The traditional rate differential between the 10 year treasury and the 30 year fixed rate mortgage has disappeared due to the mortgage crisis and other factors.   Risk is now priced higher across all credit markets, including mortgage backed securities (MBS).

The Federal Reserve’s direct purchases of mortgage backed securities initiated late last year was successful in its goal of lowering mortgage rates.   The Fed’s direct purchases of MBS has stabilized the mortgage market and lowered rates.  There are arguments being put forth that due to the Fed’s intervention, mortgage rates have artificial price support.  Nonetheless, if the historical yield spread between the bond and the 30 year mortgage is re-established, we may see a 30 year fixed rate in the 3.5% range.  Something to think about for those contemplating a mortgage refinance.

Last week, a borrower with excellent credit, necessary income and home equity was able to obtain a par rate of 4.5%.   The question of whether the Fed is manipulating mortgage pricing at this point or how long such price support can last is somewhat irrelevant.  The major fact to keep in mind is that the Fed appears to be relentless in its campaign to drive down mortgage rates.   If the Fed can stabilize the MBS market we may be looking at mortgages rates in a range we never thought possible a short time ago.

30 year fixed rate mortgages in the mid 3% range would cause a huge refinance surge.  Keep in mind that over the past five years, homeowners had multiple opportunities to refinance in the low 5% range.  Unless the borrower is taking cash out, it usually does not pay to refinance for less than a one percentage point reduction.   At 3.5% rates, it would make sense for almost every homeowner with a mortgage to refinance again.

Few May Benefit From Lower Mortgage Rates

Rates Increase

Mortgage rates increased today on a sell off in the Treasury market. The benchmark 10 year treasury note increased in yield by 16 basis points (bps) to 2.244%. The 2008 low on the 10 year treasury yield was 2.038%.

Courtesy Yahoo Finance

The increased yield on the treasury bond has resulted in a mortgage rate increase of 3/8% over the past few weeks.   A 30 year fixed rate mortgage at par today is 4.875%, historically a super low rate.  So what if rates moved up a little bit – 4.875% still sounds almost too good to believe.

Low Rate Does Not Apply To All Borrowers

Before rushing out to refinance, be aware that the advertised low rate of 4.875% is available only to the most perfect borrowers and the 4.875% rate will cost around 1 point (1% of the loan amount) plus other closing costs.

Unless a borrower has perfect credit (at least a 720 FICO score), adequate income (debt ratio of 32% or less) and substantial equity in the home (loan to value of 75% or less), the rate will be higher due to adders.  Adders are fees imposed by Fannie and Freddie if the applicant does not fit into the little box of a perfect borrower.  Adders are imposed for higher loan to value, lower credit scores and cash out refinances.  The adders can easily amount to 2% of the loan amount, or $2,000 on a $100,000 loan.   If a borrower is applying for cash out with a FICO score below 680 many lenders will turn the loan down.

Here’s an example of what used to be considered a prime borrower in the recent past.  Borrower has a 680 FICO score, adequate income and wants $20,000 cash out with an 80% loan to value and a loan amount of $160,000.   The chart below shows the cost of not being a perfect borrower as defined today.

Interest Rate

6.750%

Price Adjustments

-1 FICO 680-699, LTV 75.01-80

-0.8750 C/O Refi. LTV 75.01-80, FICO 680-699

The best rate this borrower would get quoted today would be 6.75% and the mortgage company would need to charge an additional 1 to 2 points on the loan (up to $3200 based on a $160,000 loan amount).

This is the reality of the mortgage market today.  Many borrowers applying for a refinance with visions of a 4.875% rate and a payment reduction are finding out that they do not qualify.   There is much in the news about the “mortgage refinance boom”.   Expect to see stories in a month or two about how few borrowers actually benefited from the lower rates.