Charging higher fees to a borrower who makes less money and has more debt has historically been the best way for mortgage lenders to offset the higher risk that the loan wouldn’t be repaid.
But the federal regulatory agency that sets those standards is now turning those rules upside down, with plans to implement what local lenders say is the biggest overhaul of loan level pricing adjustments – risk-based fees applied to loans – in history.
And not everyone is on board.
“Anytime there are too many changes at once, there are going to be unintended consequences,” said Peter J. Nigro, Sarkisian chair of financial services at Bryant University.
And the Federal Housing Finance Agency certainly did not hold back when it came to changing the thresholds and risk factors used to calculate the fees tacked on to a conventional mortgage loan. Among the biggest changes to the pricing scheme, set to take effect on May 1, is the introduction of a borrower’s debt-to-income ratio as a factor in determining fees; previously, credit score and loan-to-value ratio were the main variables.
Considering how a borrower’s debt impacts their ability to repay a loan seems like a logical addition to Joseph Baptista, a mortgage broker and president of Anchor Financial Mortgage Inc. in Pawtucket.
But lenders see it differently. Debt-to-income ratio is not always fixed, especially in the gig economy and side hustle era in which people’s income fluctuates, says David Gravelle, senior vice president of residential lending for HarborOne Bank.
How to calculate income and debt is also unclear. Does overtime get counted if the amount fluctuates? What about items purchased using the “buy now, pay later” option increasingly popular among retailers, which technically isn’t considered debt?
“It’s extremely up to the interpretation of the underwriter,” Gravelle said.
Even a minor difference in calculation could mean a big hike in fees if it puts the borrower above the 40% debt-to-income ratio threshold set by the FHFA. That means what a lender initially tells a potential borrower to expect in loan fees could grow by several thousand dollars when the loan is finalized.
“I worry consumers will feel like it’s a bait and switch from the lender,” Gravelle said.
Deborah Jones, senior vice president of mortgage capital markets for Citizens Bank, expressed similar concerns. Changes in pricing during a 60-day closing period threaten to erode borrowers’ trust in lenders, she says.
It’s not all bad news for borrowers. The FHFA’s changes also reduce fees for first-time homebuyers with lower credit scores, which could make homeownership more attainable for historically disadvantaged groups.
Also, higher rates for cash-out refinance loans and investors looking to buy second or third properties might ease the housing crisis. By making it harder for rich investors and aspiring Airbnb hosts to buy up the limited inventory, those homes could instead be available to people looking for a place to live, Gravelle says.
A 1.5% adjustment in pricing – up or down – is not insignificant. For example, applied to a $400,000 home – the median value in Rhode Island – that translates to a cost or savings of $6,000. But most industry experts think the changes aren’t going to sway potential buyers one way or another.
Sparse supply will keep demand and overall prices high through the rest of the year, Baptista says.
What the new fee structure will influence is what banks decide to do with their mortgages once the loans have been made. The FHFA price changes only apply to the federally backed mortgage companies, colloquially known as Fannie Mae and Freddie Mac. Fannie and Freddie don’t originate mortgages but instead buy and guarantee them, buying from banks through the secondary market. This gives lenders more cash to originate more loans.
If a bank doesn’t sell its loans to Fannie or Freddie, it doesn’t have to follow the FHFA rules. That looks increasingly appealing to The Washington Trust Co. given the complexities and consequences of the new fee structure. The Westerly-based bank already started holding a greater percentage of its loans in its portfolio rather than selling them on the secondary market. In 2021, about 75% of the bank’s $1.7 billion in new mortgage loans were sold. By contrast, the bank held about 75% of the $1.2 billion in mortgages originated in 2022, said Mary E. Noons, senior executive vice president and chief retail lending officer.
Noons expects the trend of keeping loans in the bank’s portfolio to continue in the year ahead. Another option: sell to private-label mortgage-backed securities, rather than those backed by government agencies, which again lets lenders avoid making the FHFA price changes that don’t benefit them.
Noons lamented what a growing private market could mean for Fannie and Freddie.
While both government-sponsored entities received partial blame for fueling the housing bubble that burst in 2008, the agencies also have played an important role in providing stability and liquidity in the housing market for more than 40 years.
“It’s sad to see that role diminished,” Noons said.
