The alarm bells are ringing on the mortgage refinancing boom: why Refis are so risky


The mortgage lobby opposes Fannie Mae and Freddie Mac’s new “unfavorable market refinancing fee” 0.5%, which is the “result of the risk management and loss forecasting precipitated by the economic and market uncertainty related to COVID-19 ”.

Through Wolf Richter for LOUP STREET.

The mortgage industry is in turmoil following the surprise announcement by Fannie Mae and Freddie Mac (the GSEs) on Wednesday night that they would charge an “adverse market refinancing fee” of 0.5% on mortgage refinances they they buy – “a result of risk and loss management.” forecasts precipitated by economic and market uncertainty related to COVID-19, ”said Freddie Mac’s statement sent to lenders.

The fees are designed to reduce potential losses for taxpayers who support GSEs, as GSEs now see the mortgage market, and especially refis, heading into trouble. Refis carry a much higher risk than buying mortgages. More on that in a moment.

These fees will take effect on September 1. To refinance a balance of $ 500,000, the fee would be $ 2,500. This is not the end of the world. Mortgage lenders pay these fees to GSEs, but they will try to pass them at least in part on to the borrower. The fee will be applied to refi mortgages with and without withdrawal.

Who benefits from the refi boom and who bears the risk?

On Thursday, 20 lobby groups representing the mortgage and real estate industry – including the Mortgage Bankers Association (MBA), the National Association of Realtors (NAR) and the National Association of Home Builders (NAHB) – responded with a letter, opposing at the expense, as this would threaten “emerging but unstable improvements in the national economy” and increase refi costs, which would be “particularly detrimental to low and moderate income homeowners in our country”, and therefore “contradict and undermine the Fed’s policy.

As it turns out, these 20 lobby groups represent no one other than their clients in the mortgage and real estate industry – mortgage bankers, mortgage brokers, real estate brokers, home builders and others. And these customers have all benefited immensely from the refi boom that record mortgage rates, which have fallen almost 1 percentage point since January, have sparked.

And none of the clients of these pressure groups are assuming the risks of these refi mortgages. The GSEs – Fannie Mae and Freddie Mac – bear these risks, and ultimately the taxpayer.

This then triggered two backlashes from the American Enterprise Institute’s Housing Center, emailed Thursday and Friday.

“The Housing Lobby described the GSE’s imposition of a new half-point market adjustment fee to offset loan refinancing risk as: ‘scandalous’, ‘a seizure of money’ and “based on jealousy, greed and contempt”. Nothing could be further from the truth, ”AEI’s first statement said.

GSEs are already clashing over refi mortgages, according to AEI:

  • “The share of GSEs on the entire market for refinancing receipts is now 90%, against around 75% at the start of 2020.” This is how they are exposed.
  • “The share of GSEs in the entire interest rate and term refinancing market is now 80%, compared to around 63% at the start of 2020.”
  • “Recently, the combined volume of rate withdrawals and freezes and term refinancing has been more than double the level a year earlier. This is how the refi market has exploded under record interest rates.

The refi market share of the FHA, VA and private sector lenders is declining as they “appropriately tightened credit standards,” the AEI said. GSEs also tightened standards, but “were not enough to slow their massive increases in share and volume.”

“The history of mortgages teaches us that lending in a vacuum is dangerous, and there is no indication that there is more than a massive increase in share relative to its competition,” AEI said.

“The new half point market adjustment fee is not only appropriate, but it would have been a breach of regulatory oversight not to take action,” the AEI said.

The risks for refits are high because the “value” of the house can be fanciful.

A fully documented 30 year fixed rate cash refinance mortgage with a 65% loan-to-value ratio, meaning the loan amount equals 65% of the “value” of the home, apparently leaving a lot of “equity” so apparently very low risk – has the same stressful default propensity as similar purchase mortgages with a loan-to-value ratio of 91% to 95%.

In other words, seemingly low-risk refits are as risky as much higher-risk purchase mortgages; and compared to buying mortgages with equivalent measures, refis are much riskier.

“And GSEs currently guarantee cash loans up to 80% of the loan-to-value ratio,” AEI said.

The main reason why refis are so much riskier than purchase mortgages is the simple fact that there is no arm’s length transaction and no arm’s length purchase price that determines the value of the property. House.

It comes down to this question, the AEI said: “what do you need the value to be?”

No evaluation, no problem.

This assessment risk has been further increased by the increased use of “automated assessment waivers” that ESGs use to decide when no assessment is needed. So now there is no arm’s length transaction and even no valuation.

“Because this tool is integrated with GSE’s Automated Underwriting Systems (AUSs) and a loan can be submitted multiple times, this system is subject to play. We have seen this happen with income documentation waivers. in the 00s, ”AEI said.

“Automated systems allow system-based underwriting rules and market house price information to be distributed much faster,” AEI said. “Given the 60% market share of GSEs, it would be difficult to design a system that better feeds refinancing demand and risk. ”

“Yet like the AUSs of the 2000s, the large-scale use by GSEs of automated assessment waivers today has not been tested in a top-down cycle,” the AEI said. “In the 2000s, we finally found out that they were so wrong that virtually every local market was subjected to severe house price corrections unlike any seen since the Great Depression.

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