HousingWire recently featured an op-ed advocating for Bill Pulte of the FHFA to make Fannie and Freddie (the GSEs) mortgages assumable, retroactively. The intent is noble – most mortgage borrowers are indeed locked in by low interest rates from the pandemic, draining liquidity from the housing market and not allowing these borrowers to relocate when they should. The reality is more complicated – this one-time fix is very hard to implement, would potentially cost MBS investors hundreds of billions, and could make GSE IPOs unviable. Instead, the FHFA should lay the groundwork for us not to have this conversation next time around.
The FHA’s assumable mortgages are suggested as a potential solution to the current interest rate lock-in – a qualified buyer can assume the seller’s (low interest rate) mortgage at the seller’s current rate. However, there are reasons why FHA assumptions have been almost non-existent despite the interest rate differentials. The seller might find it hard to sell the house for a higher price due to the assumable mortgage, as the appraised value of the house will not take the mortgage’s assumability into account – so the assumability might not relieve the seller’s lock-in (unless the seller also happens to find a mortgage to assume). The buyer, unless flush with cash, might also need to come up with a sizable second-lien mortgage (at a much higher interest rate) to supplement the assumable mortgage, as presumably the seller paid down at least some of the principal already – considerably complicating the already-complex process for first-time homebuyers.
Meanwhile, the MBS investors – providing trillions in liquidity and hedging the interest rate risk for the GSEs – already took considerable losses over the last few years (likely over a trillion dollars in unrealized losses), holding pandemic MBS that currently pay much lower interest rate than short-term Treasuries. Making GSE mortgages assumable retroactively, in a way that would actually help borrowers, will lower prepayment speed of these MBS even more, substantially increasing MBS investor losses even further. Investors will drive a higher spread between long-term Treasury rates and MBS rates (increasing mortgage rates) – to take into account both the new terms and the increased uncertainty about what else might change. Furthermore, the MBS investors would take action by suing the GSEs to recover these extra losses, which could amount to more than the combined GSE profits over the last decade – threatening the future of the GSEs altogether, potentially needing another highly-unpopular bailout, and killing any hope of a successful IPO, with lawsuits likely lasting years. In addition, the largest MBS investor is the Federal Reserve (through its quantitative easing) – effectively making the taxpayers responsible for hundreds of billions of losses even before lawsuits and bailouts.
Instead, the FHFA should consider how to fix the lock-in issue going forward – so that the next time we are not lamenting that we are again too late. Perhaps, the FHFA could figure out an ingenious way to bypass the implementational difficulties of assumable loans, by restructuring various contractual provisions going forward.
They would also need to help spur the development of the second lien market, to allow borrowers to bridge the gap between the current loan and the value of the property. Alternatively, the FHFA could consider a (portable) mortgage that the borrower could take with them to their next house (as long as the LTV isn’t higher or the borrower makes additional downpayment), alleviating seller lock-in by design (even for borrowers who are struggling, as they would not need to requalify), not having the same appraisal issues as assumable mortgages, and lowering the number of originations a borrower goes through (as borrowers would not need to originate new loans when they move, but might simply need an appraisal or an AVM valuation).
Portable mortgages aren’t a silver bullet either though – borrowers trading up would need more cash or second liens, interest rates will likely be somewhat higher, and giving borrowers options would decrease liquidity in the TBA market. In short, there are promising avenues, and any FHFA RFI on the topic would surely invite many informed responses.
The Federal, state, and local governments could of course do more to relieve current housing cost pressures. In particular, both removing various local zoning constraints to enable an abundance of housing supply and driving down long-term Treasury rates by slowing budget deficit accumulation would make housing more affordable, without endangering the entire mortgage system.
Alexei Alexandrov is a Ph.D. economist, who worked on mortgages and housing as a senior economist and the artificial intelligence fellow at the Consumer Financial Protection Bureau and as the chief economist at the Federal Housing Finance Agency.
This column does not necessarily reflect the opinion of HousingWire’s editorial department and its owners. To contact the editor responsible for this piece: zeb@hwmedia.com.
