Fannie Mae and Freddie Mac must not Die: Bove

by:

Mar 25 2014, 9:46AM

The current plan to wind down Fannie Mae and Freddie Mac would result in lower housing prices for everyone. It would harm the United States economy by lowering growth. It would increase unemployment.

Despite this probability, the president and Congress seem to be intent on killing these companies – and the media and public do not seem to care. The prevalent belief is that these are failed companies with failed structures that exacerbated the American housing crisis that flared up in 2008 and therefore they must be expunged from the system.

In fact, the opposite is true. For eight decades, the system that they represent was successful in allowing tens of millions of Americans to own their own homes. The system was abused by politicians, regulators, and bankers beginning in the mid-1990s and this led to the downfall of these two giant companies. It was not structure but political and financial interference with proper underwriting that created their difficulties. The reaction to these misdeeds is to eliminate these companies without considering what this will do to housing and beyond housing, the economy.

Consider the current proposals, in Washington D.C.:

  • One set of ideas would result in the elimination of the 20- and 30-year self-amortizing mortgage.
  • Another concept would result in increasing the federal debt ceiling by more than $5.3 trillion and maintaining pressure to keep raising it going forward.
  • Another option would wipe away $350 billion of tax payer equity.
  • Other ideas would result in the complete nationalization of the housing finance industry.

What is certain is that under every one of the proposals, the concept of every American owing his or her own home is now gone. The result will be to create neighborhoods of rental units – or in my view, instant slums. Given the risks implied by the current proposals, one would think that Americans would want to know more about what is happening to home finance or, more specifically, the price of their homes. To date they are not interested – and neither is the media.

It is probable that the housing industry in the United States is the nation’s most subsidized sector. The problem, of course is how do we get from the most heavily subsidized system of home finance in the western world to a system that is not subsidized at all? Clearly if the transition is not handled properly, major dislocations will emerge and these dislocations will be very painful to all Americans.

If the current plan from the U.S. Treasury clears Congress and the courts, two things will happen: Fannie Mae and Freddie Mac will stop functioning on January 1, 2018; they will then enter a liquidation phase that may take at least 10 years.

This will not be good for anyone in this country. If there is no Fannie Mae and Freddie Mac, no bank will be willing to make 20- or 30-year self-amortizing mortgages. I have spoken to at least a dozen banks who feel very strongly about this issue – they just don’t view mortgage lending as the profit center it once was in the past. It’s more of a loss-leader to attract customers and cross-sell them other products.

Banks will simply be unwilling to put 30-year self-amortizing mortgages on their balance sheets, particularly at today’s interest rates. They will be willing to make 10- and 15-year adjustable-rate loans. The math here is frightening. The median income of American households is approximately $51,000. Under the new qualified mortgage rules, if you want to buy a home:

  • You must make a down payment equal to 20 percent of the value of the home to be purchased.
  • You are not allowed to pay more than 40 percent of your household income to meet principal and interest payments.

So, if the homeowner obtains a 30-year mortgage at a 4.25-percent fixed rate, then he/she/they can afford a home worth approximately $435,000. Conversely, if all they could get was a 10-year adjustable-rate mortgage at 6.25 percent (the average over the past 20 years), they could only afford a house worth $345,000 – a drop of $90,000.

You can play with the numbers any way you want but the bottom line is always the same: Affordability drops. Housing prices must come down. Moreover, if the American banks adopt the mortgage systems widely used in Canada, the 3-5-year balloon mortgage will be back.

Of course, no one believes that this will ever happen. However, they need to think again. The program to eliminate Fannie Mae and Freddie Mac is already in place. Unless Congress acts or the courts throw out the U.S. Treasury’s plan, the price of every home in the United States is about to fall. After the fact, people will care and the media will awaken from its somnolent state.

What should be done

To me it is very clear that the following should be done to minimize the impact of the government’s withdrawal from the home finance industry.

  • The conservatorship controlling Fannie Mae and Freddie Mac should be eliminated.
  • The companies should be returned to private sector ownership.
  • The government should exercise its warrants and sell the stock in the open market.
  • The dividend on the Series A preferreds should be returned to 10 percent.
  • The two companies should have as their mission:
    1) The elimination of their owned portfolios
    2) The expansion of their insurance roles without the full faith and credit of the nation behind this insurance
    3) The requirement that they give preference to insuring long duration fixed rate mortgages
  • The Senior Preferred Stock should be placed in a new trust dedicated to funding low-income housing.

None of this requires congressional or court actions. The president is able to do it by fiat. There is no massive government takeover of the housing finance industry and more importantly no massive bureaucracy created. It is simple, low cost, and would avoid disrupting the American public by forcing the prices of their homes lower.

– By Richard X. Bove

Richard X. Bove is an equity research analyst at Rafferty Capital Markets and the author of “Guardians of Prosperity: Why America Needs Big Banks,” which is due out on Dec. 26.

U.S. 30-Year Mortgage Rates Increase for a Second Week – Bloomberg

Mortgage rates for 30-year U.S. loans climbed for a second week, cutting into affordability as the housing recovery shows signs of cooling.

The average rate for a 30-year fixed mortgage was 4.33 percent this week, up from 4.28 percent, Freddie Mac said today. The average 15-year rate rose to 3.35 percent from 3.33 percent, the McLean, Virginia-based mortgage-finance company said.

While the job market is improving, higher prices and borrowing costs are making it more expensive to own a home. Monthly payments on a median-priced three-bedroom home — including mortgage, insurance, taxes and maintenance — rose an average of 21 percent in the fourth quarter from a year earlier, according to an analysis of 325 U.S. counties by RealtyTrac released today. Mortgage rates jumped to a two-year high in August from near-record lows in May, Freddie Mac data show.

“The cost of financed homeownership is becoming dangerously disconnected with still-stagnant median incomes,” Daren Blomquist, vice president at Irvine, California-based RealtyTrac, said in the report.

Starts for single-family houses slumped in January, in part because of unusually harsh weather in much of the U.S. Builders began work on 573,000 homes at an annualized rate last month, down 15.9 percent from December and the fewest since August 2012, Commerce Department data issued yesterday show.

Confidence among homebuilders dropped in February by the most on record as snowstorms on the East Coast limited prospective buyer traffic, according to the National Association of Home Builders/Wells Fargo sentiment gauge released this week.

To contact the reporter on this story: Prashant Gopal in Boston at pgopal2@bloomberg.net

To contact the editor responsible for this story: Kara Wetzel at kwetzel@bloomberg.net

A Closer Look at Qualified Mortgages – Starting 1/10/2014

By Jeff Bounds  |  December 10, 2013

Big changes are coming for residential mortgage lenders starting next year.  That’s when new rules from the federal Consumer Financial Protection Bureau (CFPB) go into effect concerning the origination of home mortgages.

Fannie Mae has made some changes to its eligibility standards as a result, but before looking at those, it’s helpful to understand the new Ability-to-Repay and qualified mortgage (QM) rules.

Underlying the QM concept is the Ability-to-Repay rule that the CFPB issued on January 10, 2013. This rule, which takes effect on January 10, 2014, requires mortgage lenders to consider consumers’ ability to repay their home loans before extending credit to them.

Ability-to-Repay Rule

Broadly speaking, the Ability-to-Repay rule requires a lender to only make a loan that the lender reasonably believes the borrower has the ability to repay at the time the loan is made. Borrowers must provide financial documentation to support this, and lenders must verify all the documents that the borrower provides.

Under the Ability-to-Repay rule, lenders have to consider and document at least eight underwriting criteria in deciding whether to lend money for a home purchase or refinance, said John Burley, associate general counsel for Fannie Mae. The criteria are:

  1. The borrower’s current or expected income or assets.
  2. The borrower’s income and employment status if the borrower is claiming to have employment income.
  3. Monthly payments on the loan, including any possible changes if the interest rate is adjustable.
  4. Monthly payments on other loans being made at the same time secured by the property that the lender is aware of.
  5. Monthly costs of other mortgage-related obligations the borrower has, such as homeowners’ association dues or property taxes.
  6. Other loans and debts the consumer has, such as alimony, child support, or credit card debt.
  7. The borrower’s debt-to-income ratio.
  8. Credit history.

What Makes a Mortgage Qualified?

Think of a QM in three ways. At one level, it’s a loan that meets various standards that the CFPB has established. In a more simple sense, it’s a loan for which the lender presumes the borrower has the ability to repay. And for the lawyers in the crowd, the granting of QM status provides a defense for lenders against legal actions that borrowers can now bring over loans they’ve taken out and later claim they can’t afford under the ability to repay standards.

Under CFPB rules, a QM must have the following characteristics:

  • Loans may not have terms that extend beyond 30 years, and all principal must be paid in substantially equal installments over the life of the loan.
  • Points and fees, which are costs that the lender charges to the borrower during the process of applying for the loan, are capped at 3 percent of the total amount the borrower takes out for loans of $100,000 or more.

A Degree of Legal Protection

A major reason why lenders are interested in QM is that they can receive a degree of legal protection from borrower lawsuits if the borrower claims the lender failed to consider the borrower’s ability to repay the loan. Broadly speaking, there are two classes of QMs. The amount and type of legal protection the lender gets will depend on criteria of the QM loan they’ve made:

  • Safe harbor loans have annual percentage rates (APR) that are not more than 1.5 percentage points (or 150 basis points) of the “average prime offer rate” (APOR). (The APOR is determined weekly and relates to Freddie Mac’s survey.) A safe harbor loan is harder for the borrower to challenge in court because the lender is conclusively considered as having fulfilled the Ability-to-Repay rule.
  • Rebuttable presumption loans have APRs more than 1.5 percent above the APOR. The lender in this case gets less legal protection than with safe harbor loans. Borrowers with such loans can potentially win a lawsuit based on the Ability-to-Repay rule if they can prove that the lender didn’t give adequate consideration to living expenses after the mortgage and other debts they were aware of.

Fannie Mae’s New Eligibility Rules

Starting next year, Fannie Mae will impose new limits on the types of loans it can buy from lenders. This is because of instructions that it received on May 2, 2013, from the Federal Housing Finance Agency, which serves as its regulator and conservator.

For loans with applications on and after January 10, 2014, if a loan is subject to the CFPB’s Ability-to-Repay  rule, then Fannie Mae can buy it only if:

  • It is “fully amortizing,” meaning that the borrower can pay the entire principal by making all monthly payments on time. This means Fannie Mae cannot accept negative amortization, balloon or interest only loans for purchase.
  • The term of the loan is a maximum of 30 years.
  • Points and fees are less than 3 percent of the total amount of the loan (higher limits apply to loans under $100,000).

The first two items are relatively straightforward. The third is not. Burley notes that a plethora of rules govern what lenders must include, or may exclude, in points and fees.

“It’s very technical,” he said. “That’s where most of the concerns will be.”

If a loan is exempt from the Ability-to-Repay rule, points and fees must be less than 5 percent of the total loan amount for Fannie Mae to buy the loan.

It’s not Fannie Mae’s role to establish whether a given loan is a QM, nor whether it is of the safe harbor or rebuttable presumption variety. The burden for complying with those regulations rests with the lender.

Nevertheless, Fannie Mae recognizes that lenders face challenges in complying with all of the new regulations. Therefore, during a transitional period of as-yet undetermined length after January 10, 2014, Fannie Mae will not require a lender to buy back a loan on the basis of a Fannie Mae determination that the loan doesn’t comply with the QM points-and-fees requirement, as long as the loan in question is otherwise eligible for Fannie Mae to purchase.

However, lenders will be required to buy back those loans from Fannie Mae if a court, regulator, or other authoritative body determines that points and fees violated CFPB standards.

For More Information

Since the CFPB made the rules governing matters such as QM, Ability-to-Repay, safe harbor, and rebuttable presumption, that agency is the first place lenders should go to get questions answered.

Lenders may want to start with the CFPB’s website, which has a lot of resources to help lenders comply with the new rules. MBAA is also another good source of guidance.

In addition to going to the CFPB, lenders may also consult with the various law firms and advisory shops that are offering advice on complying with CFPB regulations. Fannie Mae can’t endorse any outside firm’s advice for legal compliance.

Fannie Mae has also published guidance around the eligibility requirements, including SEL 2013-06, LL 2013-05, LL 2013-06, and LL 2013-07.

Gift-funded Down Payments for Mortgage

by Ted Rood

New FHA Alternative Boosts Low Down-Payment Options

Jan 3 2014, 3:54PM

As Fannie Mae and Freddie Mac eliminated their 100% and 97% purchase loans following the housing meltdown, FHA financing once again became a preferred low down payment option. FHA loans offer a minimum 3.5% down payment, which can be gifted from a close family member. Thus, buyers whose sales contracts specify seller paid closing costs and who use the gift down payment, can often purchase a home with minimal out of pocket expenses.

FHA allows borrowers with credit scores as low as 580 to put just 3.5% down (those with lower scores face increased down payment requirements), and routinely approves higher debt loads than Fannie Mae or Freddie Mac. The combination of marginal credit scores and low (or no) buyer financial investment contributed to FHA’s default rates as the housing market crashed. As a result, FHA has raised MI significantly and has long since eliminated seller-paid down payment assistance programs.

Fannie Mae also allows down payment funds to be gifts from close family members for single family principal residences, with down payments as low as 5% for qualified borrowers. Until recently, however, private mortgage insurance (required for loans exceeding 80% of sales price) vendors required buyers to contribute at least 2% of their own funds in a transaction in addition to any gift funds. PMI provider United Guaranty recently altered their guidelines and now allow down payments to be exclusively gifts, a move likely soon adopted by competitors. The announcement gives eligible buyers a distinct advantage over FHA’s considerable MIP costs.

FHA’s upfront MIP fees are now 1.75% of the loan size added to the loan balance ($1750 on a $100,000 loan, 3.5% down), with an additional monthly charge of $108.33, which applies for the life of the loan. Conventional PMI costs vary slightly, but have NO upfront fee. United Guaranty’s pricing engine returned a price quote of $64.17/mn for a 720 score, 5% down borrower, a substantial savings of $4,399 over just the loan’s first 5 years compared with FHA’s fees.

The more conservative underwriting guidelines for Fannie Mae gift-funded down payments aim to ensure only qualified applicants receive these loans. Credit scores of 720 or higher (versus minimum scores of 620 for loans without gifts) are required. Debt ratios are limited to a 41% of applicants’ gross income, an even stricter restriction than non-gifted loans. The home must be a primary residence for all those on the loan, and no second mortgages, balloon notes, or temporary interest rate buy downs are allowed. The credit score, debt ratio, and other limitations set Fannie’s 5% down program apart from FHA’s less stringent standards and should result in far fewer defaults.

It is important to note, however, that many lenders have restrictions on gift funds, despite Fannie Mae’s acceptance. Shopping for this program may be challenging. Here’s a few steps to start the process: if you have a preferred lender, call and ask whether they offer this program; if you need a lender, contact a loan officer in your area. You might have to shop around to find a lender offering the program with no overlays.

About the Author

Ted Rood

Senior Mortgage Planner NMLS 543290, Wintrust Mortgage

 

Fannie Mae Policy Update 12/16/2013

Announcement SEL-2013-09: Pricing Update
This Announcement reports that the Federal Housing Finance Agency has directed Fannie Mae to increase pricing, reflecting a “gradual progression to more market-based pricing.” The pricing changes include increases in guaranty fees and loan-level price adjustments (LLPAs) and the elimination of the Adverse Market Delivery Charge (with the exception of four states). Both the LLPA Matrix and the Refi Plus™ LLPA Matrix have been updated and are available on Fannie Mae’s Business Portal.