Refinancing is a very attractive option for homeowners these days. With interest rates at unprecedented depths, owners are flocking to lenders to lower their monthly payments. As always, they must balance the promise of smaller remittances with the expenditures associated with closing a new loan. In many instances, it is worth it. However, a new policy instituted by the Federal Housing Finance Agency (FHFA) could tip the balance the other way. Under the new scenario, those government-sponsored enterprises (GSEs) — FannieMae and FreddieMac notably among them — that purchase mortgages from lenders will impose a .50 percent surcharge on refinance transactions.
Who Pays the New Fee?
Dubbing this tax a loan level pricing adjustment (LLPA), the GSEs will be able to reduce the amount owed to the lenders when loans get purchased. For example, a $400,000 home loan bought by FannieMae will cost the investor $2,000 (.50%) less because the lender owes the LLPA on the 400k. In other words, the lender’s take is reduced while the GSEs spending is diminished. The problem is that banks and finance companies need to sell loans to replenish their coffers, pay their employees and vendors and show a profit in the process. If loan buyers are paying less by means of the LLPA, lenders need a way to make up for the shortfall. Unfortunately, borrowers will be left in that position. An easy way to look at this is to compare rate/term refinance rates with cash out refinance rates. Cash out refinances have similar LLPA’s (Loan Level Price Adjustments) thus they have higher rates than their no cash out counterpart.
How Do GSEs Purchase Mortgage Loans?
Many borrowers have heard of FreddieMac and FannieMae but precious few have any relationship with them. When mortgages are sold by lenders, the servicing is also sold off. The GSEs do not service loans, so these entities morph into an impersonal concept known as the “secondary market.” Yet lenders that seek GSE dollars work hard to follow Fannie and Freddie rules if they wish to continue doing business. Whether loan applications are accepted or rejected, applicants can be fairly certain that a GSE guideline was involved.
The reason GSEs have guidelines is the same reason each lender has them, mortgage loans represent risk. Rules are put in place to make those risks manageable. Why? Because Fannie, Freddie, and the others want to sell the same loans they bought, except this time as mortgage-backed securities. Recognizing that riskier loans make riskier investments, GSEs tell lenders the particular conditions upon which they will purchase. Parameters are placed on credit scores, the ratio of loan amounts versus home values and the ratio of debt to overall income, to name a few.
After a lender closes a loan, documentation is forwarded to a GSE like Fannie Mae for review. If the GSE determines that all of its criteria are met, it then notifies the lender of purchase. On the other hand, if certain verifications are missing, for instance, or underwriting calculations do not add up, the loan buyer will hold up the purchase until the outstanding issues are resolved. If the loan was not disclosed, originated, processed, underwritten and closed according to GSE standards, the mortgage lender may be stuck with it.
How the LLPA Affects the Loan
The LLPA is also known as the Adverse Market Refinance Fee, in essence a tax on borrowers because of hard times. The COVID-19 pandemic has hit the lending industry with special ferocity. Under the Coronavirus Aid, Relief and Economic Security (CARES) Act, mortgage servicers are ordered to allow six to 12 months of forbearance to mortgagors due to the resulting economic downturn. This means that many fewer dollars are flowing in relative to originated loans. Although the full loan balances still remain due and payable, such revenue is delayed for some time to come.
One bright spot is that lending activity increased as interest rates fell. The new business would offset at least some of the albeit temporary losses from the many loans in forbearance. Mortgage Bankers Association (MBA) research shows a steady increase in applications of nearly 50 percent from August 2019. Meanwhile, the MBA is tracking a steady decline in the number of loans in forbearance over the last two months. All of this bodes well for lenders as they try to recover from pandemic slow-downs. Yet this progress is subject to a quick reversal.
Just as every business tax is passed on to consumers, so too will the new LLPA end up costing borrowers. These risk-based fees are not new in and of themselves. They have often applied when credit scores are iffy, LTV is on the high side, or property is pure investment and non-owner-occupied. Yet these levies relate to a weakness in the application.
The Adverse Market Refinance Fee was due to take effect on September 1, 2020, but was delayed to December 1, 2020. It applies to every conforming refinance transaction regardless of particulars. Such an expense may put a damper on home finance. Every industry trade group along with several members of the House and Senate are pushing to get the fee permanently reversed.
Why Charge More Money During Hard Economic Times?
Times are indeed tough for many but mortgage lending never significantly dropped off in the spring and summer of 2020. In a letter to its lenders, FannieMae cites “market and economic uncertainty resulting in higher risk and costs” as the reason for this new fee. What exactly that means is open to interpretation. While the effects of COVID-19 and shutdowns continue to plague states and cities, many believe such uncertainty is not at the root of this expensive change. The very future of the GSEs is more likely the motivator.
Historically, Fannie, Freddie, and GinnieMae and FarmerMac, to name others, are quasi-government corporations. They are chartered by Congress to perform their missions and are run by directors, all of whom are political appointees. That was the extent of government control until the onset of the housing/banking crisis of 2008. Responding to what appeared to be lax management, the federal powers assumed a more hands-on approach to the day-to-day activities of Fannie and Freddie. With FHFA as the primary regulator, these GSEs were subject to this greater degree of oversight for the past 12 years.
At the end of 2020, or soon thereafter, the federal agencies will release the GSEs to their original state of semi-autonomy. This means that they will have to boost their own capital reserves, as many large companies do to sustain their viability. So, entities that were chartered to promote and foster greater mortgage lending and, as a result, home ownership, will now charge extra for that privilege.
Refinance Factors by State
A new LLPA will add to the annual percentage rate of every refinance since it will become a closing cost. These are the monthly median payments in states where we lend.
Washington posts a median monthly mortgage payment of $1,826. This is on the high end in terms of rankings, falling behind Connecticut, New Jersey, New York and Alaska. Important to remember is that the new LLPA is based on the loan amount and will not change as rates fluctuate.
$1,647 is the median monthly remittance for Oregon mortgage holders. The average outstanding mortgage debt is $218,408 while home value averages $319,200, according to USA Today.
Idahoans’ payments center on $1,228, lower among the 50 states. The average mortgage debt in the Gem State rests at $163,370; the home value median is $207,100, among the bottom 10 nationally.
Colorado mortgagors make monthly loan payments, the median of which is $1,681. Its median home value is the fourth highest in the land: $348,900. The average amount of mortgage debt is $241,980.
Residents can help decide whether refinance is now feasible given the new realities by contacting a knowledgeable loan officer to discuss options.
Have Questions about Refinancing?
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