CARES Act Causes Mortgage Market To Tighten

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It is weird that when interest rates are at all time lows that people are not borrowing at record numbers. What is causing this stall in the Mortgage market?

One thing is lenders around the country are imposing stricter income, credit-score, and down payment conditions, and two major lenders even eliminated home-equity lines of credit. Mortgages have become less and less available as a result.

JP Morgan Chase stopped making loans without a 20% down payment or a credit score of at least 700, just as Wells Fargo no longer allows cash-out refinancing loans. These two banks also suspended new home-equity lines of credit.

Another indicator that something is amiss is mortgage rates themselves: They are roughly a percentage point higher than they ordinarily would be given current Treasury-bond yields.

These anomalies in the way the mortgage market would normally act can be traced back to March when pandemic-related shutdowns frightened investors, causing them to drop nearly all types of financial assets, including mortgage-backed securities. As their prices fell, yields rose, rippling through to mortgage rates.

As a reaction to the Covid-19 pandemic Congress passed a series of relief bills to help the US population. One of these bills was the CARES Act.

The CARES Act directs that if you are experiencing financial hardship due to COVID-19, you will be granted forbearance on your federally backed mortgage loan for up to 180 days with the option to extend for another 180 days.

In that legislation the government allowed homeowners to suspend mortgage payments for up to a year but provided no way to pay for this, potentially saddling lenders with the burden.

The Fed responded by cutting its short-term interest rate target a full percentage point to near zero and, in the past two months, buying more than $1.5 trillion in Treasury securities and $650 billion in federally guaranteed mortgage-backed securities. Buying at a pace that would top 2008 purchases. Treasury-bond yields plummeted to below 1% for the first time on record.

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When unemployment is high and the economy is weak it puts borrowers at higher risk of losing a job and defaulting, and typically leads to tighter credit, however what we are seeing now is unprecedented. Markets froze for so-called jumbo loans, which are too large for government backing, usually those that exceed $510,400.

The forbearance allowed in the CARES Act had unintended consequences in the complex mortgage market. Typically, a bank or finance company originates a loan and sells it to Fannie or Freddie—which then attaches a guarantee, pools the loan into a security and sells it to investors.

The banks that made the loans can continue to service them, in return for a fee, but they pass the principal and interest to those investors.

However Congress overlooked one major issue, Fannie and Freddie wouldn’t guarantee a new loan made to anyone who sought forbearance, effectively barring them from refinancing.

When forbearance is sought Fannie’s and Freddie’s policies diminish the value of the lender’s right to continue servicing a loan. The conditions under which lenders themselves can borrow from banks will change and the risk to a lender is increased that they may have to buy back a loan if Fannie or Freddie finds a problem in it.

A spokesman for FHFA said it helped make credit more available by allowing Fannie and Freddie to do something they had never done before: purchase loans in forbearance. The fees for those loans are needed to protect against higher risks of default, he said.

“Lenders’ lines of credit would have tightened and borrowers’ ability to get mortgages would have suffered” if it hadn’t acted, said the spokesman, Raphael Williams.

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The FHFA “has agreed to buy loans in forbearance on terms which no one can accept,” said Lou Barnes, a third-generation mortgage banker in Boulder, Colo.

Ian McDonald, a branch manager for Fairway in Hutchinson, said of Congross “It was a quick reaction to try to help people, but there are some serious negative effects that weren’t contemplated until just now.”

“I don’t think that’s what the federal government intended. We are worried someone is going to ask for forbearance before we can sell the loan to investors,” said Glenn Kelman, chief executive of Redfin, a real-estate brokerage firm that operates its own mortgage company.

Banks are asking for Fannie and Freddie to advance them funds to cover the missed payments since, as guarantors, the government-sponsored enterprises would ultimately have to reimburse the payments anyway. Ginnie Mae, a federally owned agency, has already done so for some payments on FHA and VA-backed loans.

Fannie and Freddie were prepared to do the same, but their regulator, the FHFA, put a stop to those plans. The FHFA spokesman said the agency hasn’t declined any official requests from Fannie or Freddie.

In an interview in April, FHFA Director Mark Calabria said the lenders’ fears were overblown and there are plenty of healthy firms to absorb the business of those that may fail.

The FHFA has said lenders must only continue to advance payments on non-performing loans for four months, after which Fannie and Freddie will take over. It also said borrowers won’t be penalized for seeking forbearance unless they actually skipped a payment. Borrowers must be current for three months before getting a new loan.

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Mr. Calabria, appointed by President Trump, has focused on preparing Fannie and Freddie to leave government control, which requires them to build up more capital by retaining profits and issuing stock. The companies and FHFA announced new steps towards privatization last week.

Some industry executives say Fannie and Freddie should be run not to maximize their profits but the broader welfare of the economy. They also say tightening conditions on refinancing a loan doesn’t protect the companies since they are already on the hook for the existing loan.

Historically, 30-year fixed mortgage rates hover around 1.7 percentage points above the 10-year Treasury yield. That spread is now 2.6 points, implying the mortgage rate should be closer to 2.5% than 3.3% now.

Such spreads are usually created when Treasury yields fall because lenders are slow to ramp up to handle refinances. The drop by the Fed is only seen when the lenders respond to the rate cuts . If lenders don’t cut their rates then the Fed’s low-rate policies won’t feed through the broader economy.

The Urban Institute think tank says nearly two out of three loans made in 2019 would fail to meet at least one of the stricter standards certain lenders have imposed since March.

“Mortgage standards haven’t yet recovered from the great recession,” said Michael Neal, a senior research associate at the institute. “So there are a number of borrowers, particularly racial minorities, who were already locked out before we came into the pandemic. Now the pandemic hits and we see a new round of tightening.”

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