As you will remember, 2008 was a painful time. The Subprime Mortgage Crisis caused the collapse of several major financial institutions and President Bush signed The Housing and Economic Recovery Act (HERA) into law. This established the Federal Housing Finance Agency (FHFA) and authorized it to place Fannie Mae & Freddie Mac into conservatorship. The agency supervises Fannie Mae & Freddie Mac and the 11 regional Federal Home Loan Banks.
The core mission of the FHFA is to ensure the regulated entities build and sustain sufficient capital and reserves, so they can continue to purchase loans from private lenders with cash or repackage them into mortgage-backed securities (MBSs). Purchasing loans from private lenders puts cash back into the primary mortgage market, meaning new loans for homes can be originated. The FHFA indirectly incentivizes banks to have healthier underwriting by setting the standards that loans must meet to be purchased by Fannie Mae & Freddie Mac. To ‘conform,’ the loans must meet maximum loan-to-value (LTV) and ceiling loan limits, and borrowers must meet minimum credit score (≥ 620) and debt-to-income ratio requirements (≤ 45%).
When Fannie Mae and Freddie Mac exchange, or swap, mortgages with a mortgage originator or aggregator for MBSs, they guarantee investors will receive the scheduled principal and interest payments. In exchange for that guarantee, they charge lenders/sellers two types of fees – upfront and ongoing. Upfront fees reflect credit risk attributes: loan purpose, LTV, and credit score. Ongoing fees reflect a loan’s product type: fixed or adjustable rate, and loan term. Since most borrowers choose not to pay ‘points,’ both fee types tend to be passed through in higher interest rates charged to borrowers.
The framework for this pricing is set by the FHFA, and over the last 18 months, they have made several important tweaks. The agency has increased upfront fees for second homes, cash-out refinances, and certain high-balance loans. They also eliminated these fees for first-time home buyers with below-median incomes and other special loan programs. This month a ‘redesigned and recalibrated’ fee matrix took effect. The agency said these changes would help Fannie Mae and Freddie Mac “achieve their mission of facilitating equitable and sustainable access to home ownership while improving their regulatory capital position,” which, of course, are competing priorities.
The changes to FHFA’s pricing include reducing the penalty for borrowers with a credit score under 680, while borrowers with good-to-great credit scores get a smaller break. A borrower with a credit score of 659 will now pay a 2.25% fee (at 80% LTV) vs. 3%. In comparison, a borrower with a score of 740 (with the same LTV) will pay 0.875% instead of 0.5%. On $300,000, that’s a decrease of $2,250 for the lower credit-rated borrower, and an increase of $1,125 for the borrower with the higher credit score. Time will tell how this affects borrowers and the health of the housing market.