It’s looks like mortgages are about to get a lot more expensive – a lot more – in the near future. Between the Federal Reserve reducing its bond buying program and changes at Fannie Mae and Freddie Mac, a lot of factors are pointing to higher rates and fees for mortgage borrowers in the coming months and years. How high will rates go? Only time will tell, but several factors are at play here.
Federal Reserve to Reduce Bond Buying
The Federal Reserve announced this week that it will reduce its purchases of mortgage backed securities (MBS) that have helped keep mortgage rates down for the past few years. Less MBS purchases means less capital flowing into mortgage markets, which means rates will have to rise to compensate.
Average 30-year fixed rates are already up more than 1% since the low hit last May, and as the Fed continues to taper, expect rates to move higher.
Fannie and Freddie to Increase Guarantee Fees
Fannie Mae and Freddie Mac have announced yet another “G-fee” increase that will take effect in the coming months. The G-fee, or guarantee fee, is a charge applied to all loans purchased by Fannie and Freddie from mortgage banks and is assessed as a percentage of the loan amount. The increase is only 10 basis points (0.1% of the loan amount) this time around (past G-fee increases have been larger), but it is yet another factor that will push rates up. If it costs lenders more to sell a loan to Fannie or Freddie, they have to make up for it in the rate and/or fees on the loan.
If you’re not familiar with the role of Fannie and Freddie in the mortgage marketplace, be sure to check out my post about conventional financing.
Loan-Level Price Adjustments to Be Revised
Fannie Mae and Freddie Mac have announced proposed revisions to their loan-level price adjustment (LLPA) matrix, which will have an enormous impact on how much consumers pay for mortgages. LLPAs are essentially charges for certain risk factors on a loan, such as credit score, high loan-to-value, cash out, etc. They are typically assessed as a percentage of the loan amount and are paid by consumers in the form of additional closing costs and/or a higher rate.
It’s been a goal of the Federal Housing Finance Agency (FHFA) to encourage more non-Fannie and Freddie lending, but I’m astounded at how steep the fee increases are (click here to see the proposed LLPA changes).
For example, under the current matrix, borrowers with an 800 credit score putting down 10% on a home purchase would pay just 25 basis points (0.25% of the loan amount) for the credit/LTV LLPA. This is a relatively small adjustment, so lenders often can just absorb it into the interest rate in a way barely noticeable to borrowers. However, under the new rules, this LLPA will triple to 75 basis points (0.75% of the loan amount). That’s a huge increase that will mean borrowers either pay a lot more in fees to get a lower rate or pay a lot higher rate to absorb this much larger pricing adjustment.
Bye Bye Punch Bowl
All the stops were pulled out to stimulate the housing market over the past few years, but it looks like the punch bowl is about to be taken away. The federal government wants to wind down the involvement of Fannie and Freddie and encourage more non-GSE capital to come back into the mortgage marketplace. Many private lenders don’t want to lend at current Fannie and Freddie rates and terms, or else they would already be doing it. This means that rates have to go up to encourage more private lenders to lend.
Fannie and Freddie (and FHA) have become the dominant sources of mortgage financing in today’s lending marketplace because they are offering rates and terms more attractive than what would otherwise be offered in a truly free lending market. Between the Fed pulling back MBS purchases and Fannie and Freddie increasing fees, rates have nowhere to go up.
It’s been a good ride for mortgage rates these past few years, but it looks like the party is finally ending.