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Blog: Time to Be Transparent about Fannie and Freddie Upfront Risk Fees

Posted on by Lindsey Johnson

Data show homeownership has become out of reach for many and that reducing or eliminating upfront fees is overdue.

By Lindsey Johnson

Eight years after the global financial crisis, the U.S. housing market still lags the recovery of the overall economy—and the homeownership rate is at a 50-year low.[1] While the new administration will have many housing related issues to address in the first few years, access to credit should not be overlooked. I was reminded of this and inspired to write this blog after reading a front page story in The Wall Street Journal on December 4 titled “Credit Restrictions Cost Home Buyers ‘Deal of a Lifetime.’”[2]

Following the financial crisis, policymakers aimed to eliminate the riskiest mortgage products on the market and shore up the financials of those institutions that make up the housing industry. And, while we cannot turn our eyes away from safety and sound mortgage lending nor can we ever allow any of the riskier types of mortgages to return that led to the financial crisis, the pendulum has swung too far in some areas. To truly address concerns about consumers’ access to mortgage finance, a number of areas of government policy need to be discussed including: 1) the GSEs’ guaranty fees (“g-fees”) policy that was adopted after the financial crisis; 2) GSE Loan Level Pricing Adjustment (LLPA) fees that were added to g-fees during the crisis; 3) private mortgage insurers’ new Private Mortgage Insurer Eligibility Requirements (PMIERs) that were established by the GSEs; and 4) the Federal Housing Administration’s (FHA) pricing and underwriting practices. We will explore many of these topics in future writings, but will focus on one specific aspect here—LLPAs.

Fannie Mae and Freddie Mac charge g-fees, which are the fees borrowers pay to have their mortgage backed by the Federal government through the GSEs. In 2008, the GSEs added LLPAs to further shield the GSEs against the risk of defaults. These crisis-era fees were levied on homebuyers in addition to other fees and costs for managing their risk, based largely on two factors—credit score and the size of their down payment—and most borrowers do not even know about these additional fees. The current president of the National Association of Realtors (NAR) put it best in an American Banker column when he stated “homebuyers are paying a steep price at the closing table in the form of unnecessary fees that, for some, put homeownership out of reach.”[3] Without being transparent about these so-called upfront risk fees, LLPAs will continue to exacerbate a serious concern over the efforts to re-balance these fees in a post-crisis environment.

Low-down payment programs are designed for families who need the help, but the impact of LLPAs on the cost of Fannie or Freddie-backed low-down payment mortgages has been chilling. The Wall Street Journal reports that, “Fannie and Freddie increased fees for riskier borrowers, widening the gap between mortgage rates available to borrowers with good and weak credit.”

This is indeed true. The Treasury Department noted in a recent report, the “credit score of the typical new mortgage borrower is nearly 40 points higher than the typical borrower in the early 2000s.” The “average credit score for those obtaining a loan backed by Fannie Mae and Freddie Mac…in conservatorship is nearly 750”—near perfect credit. And the “loan-to-value” is 80%, which means average down payments are roughly 20% of the home purchase price. These facts are “especially sobering given the fact that more than 40% of all FICO scores nationally fall below 700.”[4] I would argue that these trends mean there are many creditworthy families of all socioeconomic backgrounds deserving of conventional mortgages who are simply unable to buy their first home!

Costs of LLPA Fees on Homebuyers and Taxpayers

LLPAs impose significant costs on homebuyers and disproportionately harm first-time homebuyers and those without large down payments. If a homebuyer puts down 5% on a $200,000 home, and the borrower has a 660 FICO score and is applying for a $190,000 mortgage, then the upfront LLPA is 2.25% on this loan. The borrower will pay for this by either bringing $4,275 additional funds to closing (190,000* 2.25%) or accepting a 0.50%-0.55% higher interest rate. That higher interest rate translates to an additional $50 per month on your mortgage payment. Over 5 years that is more than $3,000 in additional interest and over the life of the loan the borrower pays more than $18,000 in additional interest.

USMI was one of 25 organizations that wrote to FHFA Director Mel Watt in June about the need to eliminate or reduce these arbitrary crisis-era fees. Fortunately, since the financial crisis, defaults have gone down for a variety of reasons, not the least of which is the fact that new underwriting rules have dramatically improved the quality of the GSE portfolio of new home loans, meaning there is a whole lot less risk on the GSEs’ books as these mortgages are performing well. Yet while the cumulative default rate has decreased from 13.7% to almost zero, GSE g-fees, which include LLPAs, have nearly tripled since the mortgage crisis. Therefore, these arbitrary fees are being imposed on borrowers, even though lending is safer and the fact that private mortgage insurance already mitigates the risk the borrower may not repay their loan. Essentially, LLPAs are double charging the borrower for the same risk. The data simply does not justify these fees anymore.

FHFA Responds…

Director Watt’s August 1 response to the 25 groups who called for FHFA and the GSEs to reduce or eliminate these LLPA fees was that “although positive developments in the mortgage market continue to occur, we believe the current g-fees and LLPAs continue to strike the risk balance.”[5] However, speaking at the MBA’s Annual Convention & Expo in October, Director Watt acknowledged that the post-2008 recovery in the housing market has been “disappointingly uneven” in many areas of the country. Not only has the recovery been slower for urban and low-income communities, but these same communities continue to have the hardest time achieving homeownership today.

NAR said in the American Banker column that the GSEs are “charging homeowners for far more risk than they [the GSEs] took on, driving tremendous profit.” The GSEs have paid more than $200 billion to the U.S. Treasury in recent years; given the GSEs are under conservatorship and are mandated to go to zero capital by 2018, the GSEs should continue to focus on providing access to credit for a broad range of borrowers.

The GSEs have a mission to “promote homeownership, especially access to affordable housing.”[6] It is time to eliminate or reduce these unnecessary fees and bring down costs for homebuyers, considering most low-down payment mortgages already come with private mortgage insurance protection—risk that Fannie and Freddie do not have to bear. Private MI has covered first loss mortgage credit risk ahead of American taxpayers for 60 years and mortgage insurers are ready to do more.

[1] Census Bureau

[2] http://www.wsj.com/articles/credit-restrictions-cost-home-buyers-deal-of-a-lifetime-1480874593

[3] http://www.americanbanker.com/bankthink/fees-meant-to-shield-gses-from-risk-are-hurting-homebuyers-1091054-1.html

[4] Antonio Weiss and Karen Dynan, Housing Finance Reform: Access and Affordability in Focus https://medium.com/@USTreasury/housing-finance-reform-access-and-affordability-in-focus-d559541a4cdc#.gu5ifppus

[5] Mel Watt, FHFA Letter to Stakeholders on LLPAs

[6] Chairman Ben Bernanke, ICBA Conference Speech: GSE Portfolios, Systemic Risk, and Affordable Housing https://www.federalreserve.gov/newsevents/speech/bernanke20070306a.htm

Blog: 2017: An Opportunity to Coordinate America’s Housing Policy

Posted on by Lindsey Johnson

By Lindsey Johnson

While the housing finance system in the United States has developed into an ad hoc set of entities and programs, so has the regulatory system around it with more than seven[i] federal agencies playing a role in the formation of policy and regulation of activities for housing finance. Despite the expansive reach of the federal government in the housing finance system and the exhaustive list of government agencies regulating it, safety and soundness gaps exist, access to credit remains tight, and potential homeowners continue to fall through the cracks. Housing policy has become political in addition to being complex and has therefore created an environment where meaningful reforms are rarely achieved. However, the outcome of the historic 2016 election means that one party will control all three branches of government starting in 2017, which presents a unique opportunity to examine the underpinnings of the housing finance system and establish a more comprehensive and coordinated approach to housing policy, rather than just tinkering around the edges of the mortgage finance industry.

Here are three overarching housing considerations and recommendations for the new Congress and Administration:

  1. There is a need for more coordinated, comprehensive, and transparent federal housing policy.
  2. All attempts to reform the housing finance system should fix the parts of the system that were and are broken, while enhancing the parts of the system that work. Part of the solution to fix what is broken is to identify and address areas of inconsistency and redundancy.
  3. Private capital should play a much greater role in the housing finance system. There should be a regulatory body that sets safety and reliability rules for market players on an equitable basis. Further private capital, not government and taxpayers support, should be encouraged to provide access to credit and protect against credit risk where possible in the housing finance system.

Since major housing policy tends to be reactionary and seldom comprehensive, inconsistencies and overlaps have developed resulting in dramatic shifts between the completely private market (PLS market), the semi-government backed market (conventional market via Fannie Mae and Freddie Mac), and the fully government-backed Ginnie Mae market (FHA, VA, and USDA). One such area of inconsistency is in low downpayment lending, which is increasing as a proportion of the overall residential mortgage market. Currently, a single borrower is subject to different requirements and pays different premium rates for insurance or a guarantee on a low downpayment loan under private mortgage insurance (MI), the FHA, the USDA’s Rural Housing Service, the Department of Veterans Affairs, or state Housing Finance Agency programs—even though the borrower’s risk profile remains the same.

A coordinated policy would inform how low downpayment lending in the U.S. is carried out. For example, it is common in other types of insurance such as crop, flood and terrorism insurance, to limit government programs to higher risk borrowers or to condition access to supplemental capacity by requiring some demonstration of the need for that capacity. The FHA’s current loan limits do not provide a level playing field nor is there a direct preference for a private capital alternative.  Instead, any preference is done indirectly through premium rate setting and competition, which results in an unstable policy environment. The resulting outcome is dramatic fluctuations between these mortgage finance markets, which at times is most evident between the private mortgage insurance market and the 100% government-backed mortgage insurance market at FHA. While it may seem normal to have some fluctuations during different housing cycles, the recent market fluctuations have most often been the result of competition for market share between the two. This is neither conducive for the most efficient and effective mortgage finance market nor does it ensure that borrowers are being best served. Furthermore, there are redundancies and significant overlap between several government agencies such as FHA and the Rural Housing Service (RHS), where on repeated occasions the GAO[ii] and others have suggested consolidating the agencies or at least specific areas of intersection between them.

Of course a true comprehensive, coordinated housing policy will require reform of the GSEs—or as previously stated, fixing the parts of the housing finance system that were and are broken while enhancing the parts of the system that work. Although housing finance reform may not be the first focus of the new Congress and Administration, significant steps could be taken in the near-term to encourage greater reliance of private capital and market discipline in the housing finance system by establishing clarity about the roles of the different agencies in facilitating homeownership and by providing much greater transparency at both FHA and the GSEs about how these agencies price credit risk. Again, this difference between agencies is particularly sharp in the case of FHA and the conventional lending space with Fannie Mae and Freddie Mac, which use private capital, such as private MI, to insure against a portion of first-loss on high LTV loans. However, in this case, a single borrower either pays a premium rate determined on an average basis (FHA) or a risk-based one (private MI), with the risk-based premium driven by “asset requirements” established by the government-guaranteed GSEs but not by the government-guaranteed FHA. So while there continues to be bipartisan support for reducing the government’s footprint and reducing taxpayers’ exposure to mortgage credit risk, the current market’s inconsistencies are considerable roadblocks to achieving that goal.

There are a number of different proposals for reforming the housing finance system, but most essential going forward is that Congress fixes one of the greatest flaws of the previous and current system, namely that government-backed entities – whether completely government controlled such as FHA or quasi-government such as the GSEs – should not set rules for and then compete on an unlevel playing field with the private market. These entities should perform explicit functions that foster greater participation by the private market, should promote a race-to-the top and not a race-to-the-bottom, and should be highly regulated. They should also be completely transparent in the credit risk they guarantee and how they price that credit risk. Transparency about how government prices credit risk would facilitate the greatest level of liquidity in these markets, and for credit risk transfer would foster an understanding of how these transactions are priced and the best execution for each. Finally, providing greater transparency will help end a structure where only a few agencies control the housing finance system because of their ownership of proprietary data, systems, and pricing. In conservatorship, the GSEs have an explicit guarantee on their Mortgage Backed Securities from the federal government. Therefore, until comprehensive housing finance reform is realized, critical steps could be taken now to improve transparency and foster greater understanding by market participants that will ultimately better inform borrowers. More transparent pricing will benefit lenders, investors, and most of all consumers and taxpayers.

As stated by former FHFA Director Ed DeMarco, housing finance reform “remains the great unfinished business from the Great Recession.” The complexity and political nature of the issues surrounding housing finance reform make it a daunting task to be sure, but the new Administration and Congress have a unique opportunity to make the housing finance system more coordinated, transparent, and disciplined to work for taxpayers and borrowers.

[i] Federal agencies involved with housing finance policy and regulation include FHFA, HUD, VA, USDA, Treasury, NCUA, and CFPB

[ii] U.S. Government Accountability Office, HOME MORTGAGE GUARANTEES: Issues to Consider in Evaluating Opportunities to Consolidate Two Overlapping Single-Family Programs (September 29, 2016).  See http://www.gao.gov/assets/690/680151.pdf.

Blog: CFPB Issues Bulletin Regarding the Cancelability of MI

Posted on by dcadmin

In case you missed it, this week the CFPB issued guidance to mortgage loan servicers confirming the requirements on the cancelability of private mortgage insurance (MI) when the borrower pays down the loan to specified levels. This is one of the advantages of private MI over loans insured by government programs like FHA that must be paid for the entire life of the loan, cannot be cancelled, and thus add significant additional costs to the borrower. Loans with private MI offer borrowers an option that is not only highly competitive in terms of pricing, but also cancelable, thus providing substantial savings to borrowers.

For more information on the differences between PMI and FHA MI visit – https://www.usmi.org/wp-content/uploads/2015/11/FINAL-FHA-Factsheet1.pdf