In addition to movements in interest rates, there is virtually no facet of the mortgage market which currently isn't under some form of scrutiny, redesign, consideration or review in 2011. There are a host of issues, most rather technical in nature, which all contribute to the uncertainty in the market and are a deterrent to improving lending conditions, reducing costs or to making the mortgage market a less-messy landscape.
Here's a brief overview of the current issues facing the mortgage market.
1. Risk-based pricing adjustments
As far as cost increases go, both Fannie Mae and Freddie Mac increased their "Loan Level Pricing Adjustments" (LLPA; Fannie) and their "Post-Settlement Closing Fees” (Freddie). Applied at the intersection of your credit score and the amount of equity or down payment you have, these increase the cost to the consumer to help Fannie and Freddie offset the risks of making loans to lower credit or equity borrowers. However, for the first time this spring, these apply not just to risky borrowers, but even to those with stellar credit and fairly deep equity stakes. Basically, costs have risen for all borrowers.
2. FHA insurance cost increases
Not the same as the LLPAs above, the FHA -- which recently changed its insurance premium structures to lower initial costs in favor of higher recurring (annual) costs -- has decided to add another 0.25 percent increase to its annual mortgage insurance premium. This adds an additional $250 to the annual cost for a $100,000 loan in the first year. It's not a huge increase, but no additional cost increases are welcome in this housing market.
3. YSP issues
While ‘YSP’ may be a rock radio station in Philadelphia, it’s also an ongoing issue in the mortgage industry.
In a new rule to be enacted this spring, the Fed plans to ban Yield-Spread Premiums (YSPs), perhaps the primary mechanism by which mortgage brokers make enough money to stay in business. The banning of the markup on a loan's interest rate is by no means music to anyone's ears, since it does threaten to put many brokers out of business, thus making it harder for borrowers to find or obtain funding (especially those outside of mainstream mortgage requirements). "Excessive YSPs" have been a topic of regulatory discussion for years and have even been implicated as a contributing factor in the mortgage market meltdown. Yet brokers contend that there's little proof that borrowers were injured by the normal use of the practice and that the Fed is over-reaching.
4. Mortgage servicing reform?
Mortgage servicers have been taken to task for their handling of the foreclosure and modification mess, last year's "robo-signing" scandal, the Mortgage Electronic Registry System (MERS) flap, and troubles in keeping up with never-ending changes to the government mortgage modification programs (HAMP/HARP/HAFA and other acronyms) have been well documented. A recently-proposed "settlement" from a group of regulators and attorneys general threatens to completely upend the servicing industry, virtually micro-managing business practices and creating new responsibilities and more, all which drive up the cost of doing business. On top of this, servicers would also collectively be socked with $20 billion in penalties, with this money to be distributed as loan principal reductions in new loan modifications. If it is accepted, these new costs and that $20 billion in penalties will need to come from the pockets of other homeowners and homebuyers, so costs of borrowing will be going up by some unknown amount.
5. Dodd-Frank and QRM
As far as we know, QRM isn't a radio station anywhere, but rather a vague concept which may come to dominate the mortgage securities industry. The Qualified Residential Mortgage (QRM) will eventually be the "standard" mortgage structure, as it will be the mortgage(s) which won't require loan sellers to retain as much as 5 percent of the value of the loans sold into securitization. At present, and while the definition isn't set just yet, this is likely to be a conforming 30-year fixed-rate mortgage with a high credit score and down payment requirement (possibly at least 20 percent down). All other loans being sold or packaged into securities will require the firm(s) who securitizes the loan to hold back a pile of cash against possible loss, called "skin in the game.” Five percent of hundreds of billions of dollars adds up to a lot of money that needs to be held back, which reduces funds available to lend... and the institution of such a standard will make loans outside any narrow definition more scarce and expensive.
6. Fannie and Freddie debate
Things have been pretty quiet on the GSE reform front since the Treasury released its working concepts for government involvement in the mortgage business -- ranging from “none” to “fully nationalized”. The debate over what to do is more likely to intensify as the year progresses, but at present it does seem like some form of the Treasury's Option #3 will be the path of least resistance, as it resembles our present structures the most, even as it depends upon a robust insurance mechanism which doesn't yet exist in the marketplace. Defining a QRM (as above) may play into this debate to a degree, as this may be the loan which any new GSE-like entities are allowed to securitize and guarantee and such. As we consider reform, it’s important to keep in mind that Fannie and Freddie play an important role in standardizing loan offerings in the way that McDonald's standardizes a hamburger, which is offered in basically the same fashion no matter where in the U.S. you go. Without a definition of a standard "conforming" mortgage to go by, there are legitimate concerns that a kind of "balkanization" of loan offerings will become the norm, where certain products might not be available everywhere.
7. HAMPering recovery?
It's widely acknowledged that the administration's plans to save the housing market through government-structured foreclosure-prevention programs will fall far short of original goals. While the Home Affordable Modification Program (HAMP) and others are slated to come to an end in 2012, Republicans have recently moved to terminate the program earlier, citing a lack of success in keeping homeowners from foreclosure. Given all the time and effort put into these ideas, it does seem likely that they will make it to their original end dates, even if indications are that privately-sponsored and individually-tailored loan modifications are performing as well or better than government-backed ones. Perhaps the remaining efforts and funding should not be directed at HAMP, but rather helping underwater borrowers refinance before mortgage rates rise and the opportunity is lost. The Home Affordable Refinance Program (HARP) is fine, but far too many homeowners fall outside the program and cannot take advantage of historically-low mortgage rates. These homeowners are missing the opportunity to recast their household balance sheets and make their homeownership experience more affordable and sustainable, which are among the administration's goals.
Coming soon to a mortgage market near you will be a bureaucracy with sweeping regulatory authority. How the new agency will change the mortgage and consumer-lending markets will remain unclear for some time, but borrowers should start to familiarize themselves with a concept that lenders have been aware of for some time: regulatory risk. Regulatory risk is a part of any regulated business model and has impacts (in this case) on the availability and the price of credit. A climate of stable regulations can become well-modeled with known costs and implications, but an unclear or stormy one is hard to plan for or quantify. In such a situation, "erring on the side of caution" becomes the order of the day, with potential effects on the price of credit tending toward the high side until the true costs of conducting business are known. In a worst case scenario, a lender may simply decide to pull away from lending at all until at least some clarity returns. If nothing else, the initial expected focus of the new bureau on mortgage disclosure reform will likely drive up the cost of making new loans to some additional degree.
9. Loan limits
Later in the year comes a change which will affect a small slice of the mortgage market, but an important one in certain areas of the country. Presently, Fannie and Freddie are allowed to purchase loans from lenders with amounts as high as $729,750. Later this year, that number will decline to $625,500. This means a segment of the jumbo mortgage market will have been returned to the private market, where lending conditions are improving but by no means normal. In normal times, banks and other lenders would make as many of these high-dollar loans as they could, then sell them to other firms, especially Wall Street, where they were turned into securities and sold to investors. In turn, this replenishes funds to make new loans and provides a profit for the lender. However, this secondary-market conduit closed in the financial market collapse a couple of years ago, and aside from two small MBS offerings over the last couple of years, it remains closed. This means lenders will need to make more loans and hold onto them (portfolio lending) which is valuable and has played an important role in the unfreezing of the high-end housing market, but there are limits on how many loans can be made or are desired to be held by any given lender. Given the challenges facing the securitization markets above, a resumption of "normal" functioning does seem well off into the future yet.
So there you have it... a general overview of the challenges and issues facing the mortgage market in 2011. You might note that we didn't even touch on real estate market conditions, with foreclosures, short sales, new or repeat loan failures and losses also continuing to pose issues for the industry as we try to find a way for the housing market to recover. This spring (and beyond), everything from front-end originator compensation to back-end loan failure management (and everything in between, it seems) is in this regulatory swirl at the moment. Homebuyers and homeowners are left to navigate this mess as they search for credit to buy and refinance homes this year. Here's wishing them "Good luck!"
Keith T. Gumbinger, Vice President of HSH Associates, is 25-year expert observer of the mortgage and consumer debt industries. Keith has been cited in tens of thousands of articles covering a wide range of consumer finance topics. These have appeared in publications and outlets including The Wall Street Journal, USA Today, Money Magazine, the New York Times, Kiplinger publications, US News and World Report, BusinessWeek, Forbes, Bottom Line Publications, and dozens of local newspapers. He has been a featured guest on NPR Radio and Oprah Winfrey's XM Radio program with Jean Chatzky, and has been occasionally seen on CNBC, CNN and the national news broadcasts for ABC, CBS and NBC television networks. Keith has authored or co-authored a number of consumer guides, including those for first mortgages, refinancing, home equity, mortgage prepayment and more, and is the primary researcher and writer for HSH.com's MarketTrends newsletter. He has contributed expertise to a number of books written by Jane White, Beth Kobliner, John Dorfman, and others. Working at the intersection of markets and people, and with a unique ability to explain today's complex consumer finance environment in simple human language, Keith helps writers and reporters better serve readers and viewers by providing practical, useful knowledge to these audiences as they struggle to understand the wide array of choices which must be made when managing their debts.