Mortgage Loan Refinancing Is Getting Costlier—What Does That Mean for Investors?

In this article

If you are in the middle of a refinance, or thinking of completing one soon, your loan may be getting costlier.

Why?

Coronavirus-related economic uncertainty may have finally trickled down to the housing market. Last week, government sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac announced a 0.5 percent adverse market fee, which will be tacked on to most refinances starting September 1.

Yep! That just happened.

The backstory

Today’s low mortgage rates have prompted a buying frenzy—and many homeowners and investors have refinanced, lowering their monthly payments and allowing them to pull cash from their equity. Low rates are great news if you’re an investor: You can either lower your expenses or access inexpensive capital for more investments.

This adverse market fee complicates things. The added refinance cost increases borrowing costs by an average of $1,400 for the average consumer. And adding insult to injury, for locked loans, this 0.5 percent fee falls to the bank underwriting the loan, negatively affecting their bottom line. That’s a double whammy to struggling banks.

The bottom line? For investors looking to refinance, things just got more expensive.

How is the mortgage industry reacting?

The mortgage industry isn’t pleased—this move to effectively raise monthly mortgage rates on borrowers has drawn an immediate backlash. Industry representatives and analysts argue that this adverse fee will make it harder for borrowers to refinance their mortgages.

The MBA’s president and CEO, Robert Broeksmit, explains that this loan-level price adjustment is unjustified, especially when the consumers are struggling with the worst economic scenario since the Great Depression.

To compound the situation, Fannie Mae and Freddie Mac have not specified an end date for the fee. Their justification is simply that the fee has been enacted “In light of market and economic uncertainty resulting in higher risk and costs.” This lack of specifics makes investors, who often rely on refinancing, nervous.

For context, the GSEs already have the financial backing of the US government—and the mortgage sector has suffered limited effects from the pandemic. Combined second-quarter earnings for GSEs have reached the mark of $4.33 billion.

What does the FHFA say?

The Federal Housing Finance Agency (FHFA) approved the GSEs’ request to implement the adverse market fee. Additionally, an FHFA spokesperson said that, because of the projected COVID-related losses, the FHFA will assure that the GSEs use the additional fee to provide liquidity across the country’s economic cycle. A Fannie Mae spokesperson has confirmed that the fee ensures that they “are able to maintain market stability during a time of economic uncertainty.”

The FHFA Director Mark Calabria warns that Fannie and Freddie have a limited amount of capital in comparison to similar-sized financial institutions. Combined, these two mortgage giants can only hold a combined buffer of $45 billion—which is quite low.

Currently, Calabria is seeking to finalize a post conservatorship capital framework for the financial giants, requiring the GSEs to hold more than five times their current capital levels amount.

Jaret Seiberg, an analyst with the Cowen Washington Research Group, says FHFA is concerned with the level of Fannie and Freddie’s capital. The initial coronavirus mortgage forbearance period will soon lapse, and many borrowers will be forced to resume repayments. According to Seiberg, this adverse market fee could be a method to accumulate capital to reduce the risk of spiking losses in the coming quarters. This fee hike requires taxpayers to help through the preferred capital measures.

What do other experts say?

Is this adverse fee action in direct conflict of the Federal Reserve’s actions to stabilize the economy? Good question. The Federal Reserve is currently purchasing billions of dollars of mortgage backed securities (MBSs) to spur the flow of credit. This fee hike makes it more expensive for consumers to take advantage of current record-low interest rates—and could negate the Federal Reserve’s attempts to lift the US out of this current economic crisis.

Greg McBride, the chief financial analyst at Bankrate, says the new fee is enough to make the Federal Reserve reconsider giving up its MBS purchases. This is a bit ironic: The Federal Reserve is printing money to purchase government-guaranteed mortgage-backed securities. Those purchases should keep markets functioning, bring down mortgage rates, and facilitate refinancing with the motive of putting monthly savings into consumers’ pockets. But this fee hike implies that FHFA will grab the savings from consumers and put it into Frannie and Freddie’s pockets instead.

The Community Home Lenders Association has also pressed Frannie and Freddie to revoke the policy announcement. Scott Olson, the group’s executive director, states that when borrowers are refinancing due to historical low mortgage rates, it strengthens their finances—especially important during a global pandemic. Thus It’s unethical, he says, to raise mortgage rates and increase the cost on working families. It also limits investors’ ability to pump money into their communities via rehabs and refinancing.

Because the GSEs provided such little notice, they could have created an interim problem for loans already locked—forcing lenders to bear the cost of the fee, not the borrowers. That puts additional pressure on small lenders already struggling.

One point in favor of the adverse fee action: Analysts with Keefe, Bruyette and Woods explain that the fee means a moderate hike for borrowers.

With this decision, the FHFA has put two objectives in direct conflict: Supporting the finances of enterprises that it wants to see privatized and enacting prudential regulation. Private shareholders, like Fannie and Freddie, will receive an advantage at the expense of borrowers and taxpayers.

Additionally, it directly conflicts with the policy of the Federal Open Market Committee (FOMC): Lowering interest rates and using high volumes of loan refinancing to pump up the U.S. economy’s liquidity. One would think that this sanction of FHFA seems to sabotage the FOMC’s action and hamper the economic recovery of the country.

So what should investors think?

While the cost of this “refinance tax” negatively impacts any investor’s plan to refinance, a savvy investor should complete a stress test analysis before refinancing properties, anyway. After all, mortgage rates do change in response to the market—it’s certainly possible rates could have risen an unexpected 0.5 percent, even without this adverse action. A smart strategy should be able to accommodate the fee over time.

What is truly alarming? The bulk of the burden will fall heavily upon lower-income households who desperately need the liquidity in this time of need.

How do you think this adverse market fee will affect investors?

Tell us in the comments below.

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