As a result of the unprecedented COVID-19 pandemic, the Federal government has taken several steps designed to help lower interest rates and mitigate the impact on families and businesses. However, given the way the mortgage market operates, some of these actions also have had unintended consequences. How do we expect the mortgage market to be impacted by recent actions? And, what does it mean for homebuyers?
The majority of home loans are issued by independent mortgage lenders. Typically, after a loan is closed, it is delivered to an aggregator and packaged up with other mortgages that have similar characteristics into a mortgage-backed security (MBS). These MBSs are sold to investors on the secondary market which creates capital for lenders to make additional home loans.
Beginning in mid-March, the Federal Reserve began buying MBSs, ultimately purchasing about $250 million worth over a two-week period in order to lower mortgage rates. The actions by the Federal Reserve did, indeed, lower rates briefly; however, rates had been extremely volatile leading up to the large MBS purchases, which led to a different problem in the mortgage market—namely a dramatic increase in margin calls on hedges lenders enter into to protect themselves from losses on loan rate locks.
According to the Mortgage Bankers Association, “[f]or a significant number of lenders, many of which are well-capitalized, these margin calls are eroding their working capital and threatening their ability to continue to operate.”
At the same time, lenders face unprecedented margin calls from investors, the Federal Housing Finance Agency (FHFA) has directed Fannie Mae and Freddie Mac to offer payment forbearance to mortgage holders impacted by COVID-19 for up to 12 months. These payments will ultimately have to be made by borrowers, but in the meantime, mortgage servicers still have to pay investors even if the borrower stops making payments. Consequently, the value of servicing the loan is now eroding, which is causing an increase in the rates being offered to borrowers today.
What does this mean for buyers?
There are several implications for buyers looking to secure a mortgage in this volatile environment:
- The situation faced by the mortgage industry could make it difficult for some lenders to make loans to new borrowers, at least in the short term. A lack of sufficient personnel to process applications continues to be a constraint, and the margin calls may leave mortgage lenders with fewer resources to respond to loan applications.
- Despite the Fed’s unprecedented actions, mortgage rates will not necessarily drop further. There are many other factors driving rates, including demand in the secondary market, servicing value (the income the servicer receives for managing payment collections, tax and insurance payments, etc.), and the overall credit quality of the loan.
- While Fannie Mae and Freddie Mac have stated that they are relaxing some requirements to make it easier for borrowers to complete loan applications, in practice, requirements have actually been tightened. As a result of the Fed’s actions, the organizations that purchase and aggregate mortgage loans are increasing credit standards to improve the quality of the loan to ultimately attract better pricing when the loans are packaged and sold on the secondary market. Therefore, borrowers could actually face increased credit score and down payment requirements, requirements of reverification of employment immediately before closing; and, in some cases, certification by the lender, after closing but prior to delivery, the borrower has not requested a forbearance on payments.
- Homebuyers who are in the process of applying for a home mortgage will find it more difficult to time when to lock in their interest rate. They may also find rates higher than they expect, and rates may fluctuate widely, even within a 24-hour period. The average rate on a 30-year fixed-rate mortgage during the week ending March 26 was 3.5%, but there has been significant volatility on a day-to-day basis.
The situation is changing rapidly, and potential new actions from the Federal government could alter the dynamics in the mortgage markets again. The important thing is for homebuyers to be in close contact with their lender to be sure that their mortgage application process is on track and that their loan terms have not changed.
Virginia REALTORS® is continuing to monitor conditions in the mortgage industry. Visit Virginia REALTORS® COVID-19 Resources and Updates Page often for new information in our Mortgage Rates FAQ.