Mortgage Refinances Just Got More Expensive: FHFA Unveils New Fee

Last week, the director of the Federal Housing Finance Authority made a surprise announcement that affects all refinances. Starting September 1, refinance loans will incur a new loan-level price adjustment. This fee is equal to 0.5% of the loan amount.

Because the Federal Housing Finance Authority (FHFA) oversees Fannie Mae and Freddie Mac, all conventional loans backed by these two government-sponsored enterprises are adversely affected by this fee.

FHFA Announces New Refinance Fee

FHFA’s director, Mark Calabria, believes in the privatization of all industries and services. He ascribes to a classic Reagan-era doctrine when it comes to Federal Agencies. To privatize Fannie Mae (FNMA) and Freddie Mac (FHLMC), both agencies need a sizable pile of money—significantly more than what they currently have.

Refinances are up over 800% from this time last year due to the historically low-interest rates. Director Calabria does not want the government to do any of the bailing out we saw after the crash in 2008. In order to avoid history repeating itself, he has determined that Fannie and Freddie need to be more financially insulated.

Essentially, Calabria capitalized a golden opportunity to increase Fannie and Freddie’s stockpile of cash through the recent boom of refinance transactions.

Since the COVID pandemic hit, the Federal Reserve has been pumping money into the mortgage-backed securities market. Buying up large quantities of mortgage bonds is a common practice known as quantitative easing. The goal is to reduce interest rates and give relief to American homeowners struggling to make ends meet during a financially unsettling time.

But some interpret the new refinance charge, which has been termed an “adverse market refinance fee,” as a cash grab. In its announcement, the FHFA stated that the intent is to increase cash reserves ahead of an anticipated downturn in real estate. So, in case of a rise in short sales and foreclosures in 2021, they are stacking money to stay afloat.

Impact on Mortgage Rates

A direct result of last week’s FHFA decision, interest rates ticked up about 0.25%. Let’s put that in perspective. The same rate lenders may have offered at no points or par (click here for what that means), you would now be paying 0.5% of your loan amount as an added fee for doing a refinance. This occurs because interest rates and fees have a direct relationship.

Aside from costs associated with completing a mortgage transaction, there is a specific cost tied to each interest rate. What lenders do not often tell you is that there are about 20 rate options available for every mortgage product in increments of 0.125%. You can pay tons of money and get the lowest rate on their rate sheet. Alternatively, you could get a significant credit toward transaction-specific costs (appraisal, underwriting, escrow, etc.) by choosing a higher interest rate. It is a sliding scale.

Most consumers end up choosing something close to par, or no points. This means there is no cost or credit to lock-in that specific interest rate. But what was par prior to last week is now a cost of 0.5% of your loan amount, resulting in a higher rate to offer par pricing.

How Did We Get Here?

What they are doing looks like posturing. Fannie Mac and Freddie Mac should be able to stay afloat in case of an economic downturn in real estate values without having to impose this fee.

Earlier this year, with the threat of a massive rise in foreclosures due to COVID-related unemployment, the Federal Government required Fannie and Freddie to publish guidelines on mortgage forbearance. The government also placed a nationwide moratorium on all foreclosures due to a concern rising foreclosures would have on the national economy. Thereby, causing forbearance requests to skyrocket.

When forbearance requests first started, the Federal Reserve looked to the FHFA to help mortgage servicers stay afloat, offering liquidity when needed to shore up losses from forbearance requests. In doing so, they guaranteed mortgage bonds would continue to deliver a yield, which protects their low-risk status to institutional investors, driving more money into the mortgage bond market, pushing interest rates lower and lower.

The idea is that if mortgage bonds stopped performing, they would become a risky investment, making mortgage bond prices drop significantly and causing rates to skyrocket—the very domino effect everyone wanted to avoid.

As director of the FHFA, it seems Mark Calabria did not want to be the piggy bank for mortgage servicers. He didn’t want to dip into the nearly $22 billion in reserves (and that’s just Fannie’s number) to accomplish this, thereby weakening the chances of disconnecting from big brother, the Federal Government. He finally agreed to help—but on his terms, which included additional fees to banks. And those inevitably ended up getting passed on to consumers.

From the FHFA’s perspective, there is a trade-off in the market. We have high unemployment, a lot of people not paying their mortgage, and no foreclosures happening. There is artificial stimulation, which is keeping all of this intact—and it comes at a price.

True to form, anything that comes at a price and is related to the government eventually comes out of our pockets.

However, the FHFA is justifying the new fee like this: Mortgage interest rates have been trending downward in the wake of the coronavirus. Lenders have not lowered their rates as much as they could have to match where mortgage bond prices are currently. The reason for this is simple: It would break the banks.

The U.S. financial system does not have enough liquidity to refinance the $11 trillion in outstanding mortgages, nor do they have the manpower. By lowering rates at an incremental pace, they can keep up (albeit barely) with the onslaught of refinance requests hitting lenders daily.

Calabria explained this is the key reason to tack on the new adverse market refinance fee. While it is not good news for homeowners or banks, the market will absorb the fee. Interest rates will likely continue to trend downward. In fact, I’m betting in about a month, rates will probably be back to where they were just before FHFA made this announcement.

Some Banks Likely to Shutter

One last thing to note that showcases the nature of the current leadership within the FHFA is its timing. The timing was not very good from an economic standpoint—and not good in terms of how it affects American Families. But what’s most shocking is that its effective rollout date is unprecedented.

In the past, every time Fannie Mae and Freddie Mac came out with a new fee related to conventional loans, banks had 60-75 days’ notice to start implementing these fees. This time they were given less than 30 days. Most interest rate locks are for 30 days.

The new fee does not just affect homeowners’ finances. It will wipe out nearly 25% of liquidity reserves for most medium- to large-sized mortgage banks, as well. This will likely result in bankruptcy for some smaller mortgage lenders.

Without giving proper notice for banks to absorb this fee, many banks have billion-dollar-plus pipelines of locked loans, which will incur this 0.5% fee. A lot of wholesale mortgage lenders don’t even have 0.5% in margins on their loans, so they will be taking a loss on each loan delivered within this short time frame.

What Americans Should Do Now

Rest assured, we are not powerless. As tax-paying Americans, we can call our representatives and ask for this to be reversed. An action step would be to have congress introduce legislation that would reverse this fee or put a check on the power that the director of the FHFA has to introduce new fees—particularly at a moment’s notice.

What do you think about this announcement and what do you foresee happening in the coming months as a result?

Share in the comment section below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.