Federal Housing Finance Agency (FHFA) Administrator Sandra Thompson recently announced that she would conditionally approve Freddie Mac's PILOT to purchase second mortgages. I am personally a vocal supporter of this initiative and applaud the decision.
Community Home Lenders of America (CHLA) was quick to voice its support for this pilot program: The program is undoubtedly a win for homeowners, and many of CHLA’s members are enthusiastic about helping borrowers by participating. The FHFA cleverly used the new product approval process to hear public input and make modifications.
So I was a bit surprised to see that CHLA was the only major industry group to support this pilot.To be clear, second mortgage loans are expressly permitted by Freddie Mac's charter. [Section 305(a)(4) – 12 USC 1454(a)(4)].
And while it's technically a new product, it's by no means a new feature: Freddie Mac has previously purchased cash-out refinances, which allow homeowners whose homes have appreciated in value to access some of their home's equity.
What has changed is that long-term mortgage rates have skyrocketed from a low of 3% a few years ago to around 7% today. As a result, a cash-out refinance doesn't make sense for homeowners with low-coupon loans due to what many consider to be the “lock-in effect.” That means you're paying 4% more per year on your existing $300,000 loan to borrow an extra $50,000. That extra $50,000 can easily exceed 30%.
This is where Freddie Mac second mortgages come in. Borrowers achieve the same results as cash-out refinances of years ago, borrowing only the amount of the new second mortgage at today’s higher interest rates, while preserving the significant value of the homeowner’s first mortgage, which is 3% or 4% below current market rates.
CHLA welcomes debate on this issue. Find out what critics of Freddie Mac's second mortgages are saying.
The first objection is that this poses additional risk to Freddie Mac. This argument is difficult to make, as the approved pilot program has many limitations: the program is limited to primary residences, loans must have originated at least 24 months ago, the combined LTV of the first and second loans cannot exceed 80%, and the maximum loan amount is $78,277. Additionally, the pilot program will initially have a loan cap of $2.5 billion.
So the risk argument is completely irrelevant.
The second objection is that there are already ample private sector lending options for this loan product (mainly banks and a small group of PLS originators). However, banks are already heavily capitalized and dealing with a large overstock of underwater commercial real estate loans, so it is unlikely that they will be overly aggressive in this product segment. We also know that other options often have double-digit interest rates and will always struggle to meet the requirements for high-cost and high-value mortgages. To make matters worse, high-interest “predatory” or “subprime” loans can put your home at risk if structured as a second mortgage.
The reality is that the interest rates and terms on Freddie Mac second mortgage loans are significantly better than most second mortgage loans currently available for the same reasons that interest rates on GSE first mortgage loans are generally significantly better.
The main reason Silicon Valley Bank (SVB) and other federally regulated banks collapsed last year was because they borrowed short-term and lent long-term. Since the 2008 housing crisis, banks have largely retreated from mortgage lending, and the risk of SVB borrowing short-term/lending long-term has exacerbated this problem.
CHLA might also point out that banks have not always had the best track record with second mortgage lending. Banks' excessive lending in second mortgages leading up to the housing crisis contributed greatly to the decline in mortgage collateral values, exacerbating problems with the underlying first mortgages. Ultimately, the Treasury Department was forced to adopt policies that disadvantaged homeowners in order to protect banks from huge losses on second mortgages, as well as the $700 billion TARP bailout that went primarily to the largest banks.
But at the end of the day, this is typical of the types of discussions we have had and will continue to have about the mission, role and product scope of Fannie Mae and Freddie Mac. These decisions require a framework. And we have a framework: regulatory requirements for approval of new products by FHFA, based on certain factors.
These factors were: (1) the impact on the GSEs' mission, (2) the impact on the stability of mortgage finance, and (3) the impact on the competitiveness of the housing finance market. FHFA's conclusion was that the new product would be “in the public interest.” This analysis was contained in FHFA's original Federal Register notice and was endorsed after extensive public comment.
First, there is a demonstrable “borrower benefit,” as FHFA outlined in its detailed analysis. Additionally, FHFA notes that a secondary benefit of the product is that it increases competition among second mortgage lenders.
Second, it furthers one of the GSEs' primary missions: providing market leadership. An FHFA Federal Register analysis noted that Freddie's product “may enable standardization of data and processes, leading to increased operational efficiency.” Freddie's unified ownership of both mortgages also could make loss mitigation easier for distressed borrowers, compared with the difficulties of mitigating losses with fractional ownership of mortgages (a lesson learned during the 2008 housing crisis).
Ultimately, CHLA is somewhat disappointed that FHFA significantly scaled back its original proposal in its final approval, but understands it faced strong opposition and criticism from industry.
There are also guardrails for a possible expansion of this pilot: FHFA explicitly states, “Following the conclusion of the pilot, FHFA will analyze data on Freddie Mac's second mortgage purchases to determine whether the objectives of the pilot have been achieved. FHFA has determined that any increase in the volume or extension of the duration of the pilot, or conversion of the pilot into a program activity, will be treated as a new product subject to public notice and comment and FHFA's approval. Any subsequent approval will be based on the preliminary results of the pilot.”
I am confident that after analyzing the pilot loans and comparing them with market alternatives, FHFA will conclude that the pilot should be expanded.
Taylor Stork, CMB, is Chief Operating Officer of Developer's Mortgage Company and Chairman of Community Home Lenders of America (CHLA).
This column does not necessarily reflect the opinion of HousingWire editorial staff or its owners.
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