Federal Housing Finance Agency (FHFA) Director Sandra Thompson recently announced its conditional approval of Freddie Mac pilot to purchase second mortgages. I’ve personally been an outspoken supporter of this endeavor and I applaud this decision.
The Community Home Lenders of America (CHLA) immediately issued a statement of support for this pilot. It is unquestioningly positive for homeowners and many of our CHLA members are eager to help their borrowers by participating. The New Product approval process was used adroitly by FHFA to hear public comments and make modifications.
So CHLA was somewhat taken aback that it has been almost alone among major trade groups in supporting this pilot. Let’s be clear. Second mortgage loans are specifically authorized in Freddie Mac’s charter [Section 305(a)(4) – 12 USC 1454(a)(4)].
And, although technically a new product, this is not in any way a new function. Freddie Mac has long purchased cash out refinances, which give homeowners whose homes have appreciated in value the ability to access some of the equity in their home.
What has changed is the skyrocketing of long-term mortgage rates, from lows of 3% a few years ago to around 7% today. As a result, cash-out refinances don’t make sense for homeowners with lower coupon loans due to what many have deemed the “lock-in effect.” It would mean paying 4% a year more for the existing $300,000 loan just to access another $50,000. The add-on rate on that $50,000 could easily be over 30%.
That is where the Freddie Mac second mortgage comes in. The borrower accomplishes the same result as a cash-out refinance from a few years ago, borrowing at current, higher rates for ONLY the new, second mortgage amount. The significant value of the homeowner’s current below-market 3% or 4% first mortgage is retained.
CHLA welcomes debate on this issue. Let’s examine what the detractors criticizing these Freddie Mac second mortgage loans are saying.
The first objection is the claim that this injects more risk for Freddie Mac. It seems hard to make this case, as there is a plethora of limitations under the approved pilot. The program is limited to primary residences, the loan must have been originated at least 24 months prior, the combined first and second loan LTV can’t exceed 80%, and the maximum loan amount is $78,277. Moreover, the pilot is initially limited to $2.5 billion in loans.
So, the risk argument simply doesn’t stand up.
The second objection is that there are already sufficient private sector loan options for this loan product — primarily the banks and a small cohort of PLS originators. But banks are already strapped to a significant degree, dealing with large overhangs of underwater commercial real estate loans, thus we don’t see banks being overly aggressive in this product sector. We also know the other options out there often have rates in the double digits and routinely struggle to satisfy the High Cost and High-Priced mortgage requirements. Worse yet, “predatory” or “subprime” loans at high rates, which if structured as a second mortgage, could put the home at risk.
The reality is that the rates and terms for the Freddie Mac second mortgage loans will be significantly better than most second mortgage liens publicly available today — for the same reasons GSE first mortgage rates are generally significantly better.
Silicon Valley Bank (SVB) and other federally regulated banks have gone bust in the last year in large part because they borrowed short and lent long. Banks have largely retreated from mortgage lending since the 2008 Housing Crisis — an issue which the SVB borrower short/lend long risks are further exacerbating.
CHLA might also point out that banks do not exactly have the best track record in terms of second mortgage lending. Bank excesses leading up to the housing crisis in second mortgage lending were a major contributor to underwater mortgage loans and exacerbated problems with the underlying first mortgage loans. Ultimately, the Treasury Department had to adopt policies which hurt homeowners in order to protect banks from massive losses on their second mortgage loans — along with a $700 billion TARP bailout that largely went to the big banks.
But ultimately, this is the classic type of debate we have engaged in and will engage in going forward regarding Fannie Mae’s and Freddie Mac’s mission, role and range of products. A framework for these decisions is needed. And we have one — the regulatory requirements for FHFA approval of a New Product, which is based on specific factors.
These factors are (1) impact on the GSE’s mission, (2) impact on stability of mortgage finance, and (3) the impact on competitiveness of the housing finance market. FHFA’s conclusion was that this new product “is in the public interest.” The analysis was laid out in FHFA’s initial Federal Register notice and was upheld after extensive public comment.
First, there is demonstrable “borrower benefit” — as the FHFA outlines in a detailed analysis. FHFA also notes that this will encourage more competition among second mortgage lenders, a secondary benefit of the product.
Second, is that this would further one of the major GSE mission responsibilities, which is to provide leadership to the market. The FHFA Federal Register analysis points out that the Freddie product, “may provide data and process standardization to drive operational efficiency. . .” And Freddie’s uniform ownership of both mortgages may make loss mitigation easier for distressed borrowers compared to loss mitigation difficulties with split mortgage ownership (a lesson we learned in the 2008 Housing Crisis).
Ultimately, CHLA is somewhat disappointed that FHFA scaled back the initial proposal so much in its final approval — but we understand it faced strong industry opposition and criticism.
There are also guardrails about a potential expansion of this pilot. FHFA has clearly stated that, “Upon the pilot’s conclusion, FHFA will analyze the data on Freddie Mac’s purchases of second mortgages to determine whether the objectives of the pilot were met. FHFA has determined that any increase to the volume or extension of the duration of the pilot, or a conversion of the pilot to a programmatic activity, would be treated as a new product that is subject to public notice and comment and FHFA approval. Any subsequent approval would be informed by the preliminary results of the pilot.”
I am confident that after analysis of the pilot loans, and a comparison to alternatives in the market, that FHFA will conclude that the pilot should be expanded.
Taylor Stork, CMB is the Chief Operating Officer of Developer’s Mortgage Company and the President of the Community Home Lenders of America (CHLA).
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