Dennis' Mortgage Blog

Question of the week:  What exactly is Fannie Mae, Freddie Mac and FHA, how do they work and why do we have them?

Answer:  For long time readers of my Weekly Rate and Market Update with a firm grasp of Fannie/Freddie and FHA you can move along if you wish. This will be an over-simplified explanation and I will try to keep out of the weedy details.  I will separate Fannie and Freddie from FHA for the discussion.  As well Fannie and Freddie will be treated the same.

FNMA/FHLMC:  Before they were Fannie Mae and Freddie Mac they were respectively the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation.  They are Government Sponsored Entities, or GSEs, with government charter and some oversight—as we have learned not enough, or perhaps too much, in the past.  The GSEs have their own stock you can buy and sell.  In 2008 the U.S. government took 80% ownership of the GSEs.

The primary purpose of Fannie/Freddie is to provide liquidity to the mortgage industry.  It does this by purchasing closed mortgages from lenders.  By selling its mortgages to Fannie or Freddie a lender exchanges one asset, mortgage paper, for another asset, cash.  It can then lend the cash to a new set of borrowers. 

Fannie and Freddie also set underwriting criteria that must be met for a funded loan to be purchased.  Fannie and Freddie have different criteria and originators can determine which criteria best meet their borrowers’ circumstances.  If a loan is funded and does not meet the criteria of one of the GSEs then it is sent back to the lender, what is known as a “buy back” and the lender must keep that loan on their books and/or correct the deficiencies so Fannie or Freddie may buy it back.

It is the buy-backs that have created the tightness in the mortgage lending market.  Underwriters and lenders are getting significantly more detailed in fulfilling the underwriting guidelines of Fannie or Freddie, requesting more evidence and supporting documents for loan files, appraisal reviews and other items from escrow and title.  They are doing this to ensure the mortgage they are underwriting will be purchased and kept when sold to Fannie or Freddie.

Fannie and Freddie have the cash to buy the mortgages as they also sell the mortgages, or rather they sell securities, or bonds, backed by the mortgages. Known as Mortgage Backed Securities, or MBS, investors bid on pools of MBS and receive the interest paid on the mortgages and when the mortgages pay off the investors receive part of their investment back.  As investors actively buy MBS they bid up the prices and mortgage rates drop; as investors shy away from MBS prices drop and mortgage rates rise.  If investors feel economic conditions necessitate higher rates they will act accordingly in bidding for Fannie/Freddie offerings creating higher rates.

Here is how your mortgage flows through from my desk to some pension fund in Oklahoma that invests in MBS.  After we originate the loan and go through the underwriting process we fund the loan one of two ways.  Either we fund it ourselves as a correspondent and sell it to one of our lending partners, or it is funded by a lender directly.  Either way your loan ends up with a lender that has underwritten and approved all the evidence in the file supporting your application.

Once your loan is thoroughly vetted at the lender it is placed in a pool with other mortgages to meet a commitment the lender has purchased from Fannie or Freddie.  You may be part of a $25 million pool with an average interest rate of 4.75%.  Once the pool is filled it is sold to Fannie or Freddie.

Fannie/Freddie then review the pool and ensure the mortgages in it meet their criteria and standards. Once the pool is “clean” it is then packaged as a Mortgage Backed Security issue and the issue is put on the market for investors to bid and buy.

So an investor in Oklahoma buys all or part of the pool.  Their money goes to Fannie Mae.  Fannie then uses the money to purchase its next pool from DCS Lending.  DCS Lending then uses that money to fund a $375,000 mortgage for your neighbor.  And the cycle starts again.

Even though Fannie or Freddie may own your loan, you still pay the lender you pay because they retain the servicing rights.  When you make your payment the lender charges a small fee to manage the collections of the mortgage and passes your payment along to the investor in the MBS.

FHA:  Very similar to Fannie and Freddie with a big difference: it is and has been the government.  Also making a difference is the mortgage insurance collected as part of every FHA mortgage that goes into a pool to protect investors—or rather the U.S. Government.  FHA mortgages are also packaged and sold as Mortgage Backed Securities, through the Government National Mortgage Association, known as Ginnie Mae.  Ginnie however does not actually own the mortgages, as Fannie and Freddie do, but rather is a conduit for investors and brags to investors “fully backed and insured by the U.S. Government.”  Basically an investment in Ginnie Mae MBS is a guaranteed return, guaranteed by you and me.

The purpose of the mortgage insurance for FHA loans is to off-set any losses the government may incur between homeowners who default on their mortgage payments and investors who want their guaranteed return.  Currently the gap is not being sufficiently filled by the mortgage insurance collections, which I will cover down below.

FHA has its own underwriting standards and guidelines, including standards for originators (as part of our retaining the ability to originate and fund FHA mortgages Stratis Financial must go through a thorough annual audit of our financial standing and operations and processing standards).  Loans that meet the criteria are insured by FHA.

FHA mortgage rates have dropped considerably in relation to conventional rates of Fannie and Freddie.  The primary reason for the drop is the government guarantee to investors.  Fannie and Freddie rates have been so low for a similar reason.  Since the government took control Fannie and Freddie have been given unlimited access to the U.S. Treasury to off set losses and retain liquidity, what amounts to a government guarantee for investors.  Remember there is not such thing as a “government” guarantee; it is actually a U.S. taxpayer guarantee; you and me.

Have a question for me?  Ask me!

Home prices way up.  The median home price in California in May was $278,000, up over 20% from May 2009.  With fewer foreclosures in the lower price ranges and homes over $500,000 consisting of 21% of the market the upper price ranges dragged the median price up.  Many mortgage companies and mortgage insurance companies have removed the “declining market” label from Southern California, indicative of rising values.

What impact did the IRS home buyer tax credit have?  As you may recall eligible home buyers need to enter contracts to purchase homes before midnight April 20, 2010 or miss the opportunity to qualify for the IRS tax credit being offered.  As a result existing home sales and purchase mortgage applications surged in April.  From the end of April through the first week of June purchase mortgage applications dropped every week from the week before.  Going from approximately 40% of all applications taken at the end of April, purchase mortgage applications consisted of barely 25% of total applications in the first week of June.  Total purchase applications in May 2010 were 30% lower than in May 2009.

The lack of purchase mortgage applications in May will be more apparent next week when existing home sales for May are reported.  The number should be significantly below the April sales numbers as buyers that would have purchased in May were sucked into the tax credit deadline period and purchased in April instead. 

Stagnant economic numbers from other areas of the economy also point to a slow down in May, or at least a stall, for the economy.  Retail sales declined from April to May, consumers were reticent to spend money.  Two major inflation indexes, the Producer Price Index and the Consumer Price Index (PPI and CPI) both declined in May.  Meaning prices for goods and services across the economy went down approximately 0.3%.  Leading the drop were prices for food and energy.  Falling prices and lack of employment gains are not good news for an economy trying to recover from a deep recession. 

The good news could be that last week purchase mortgage applications increased from the prior week—the first time in six weeks the index did not decline from the prior week.  This indicates more homes were purchased than the prior week.  Which could mean that May was a blip on the recovery and not the indication of any complete stall of economic recovery.  Challenging this optimism was the increase in unemployment claims last week, 12,000 claims higher than the prior week and totaling 472,000 Americans filing for first time unemployment insurance.

Any economic recovery will be slow and even slower will be the re-hiring of the millions of Americans who are out of work.  These factors are being cited by members of the Federal Reserve to support their stance on keeping interest rate low for an “extended period of time.”  Negative price indexes support this position as well.

FHA mortgages will get more expensive, a lot more expensive.  Congress passed legislation this week which will allow FHA to almost triple the monthly mortgage insurance (MMI) premium from 0.55% to 1.5%.  This increase in premium will have a net impact of lowering the maximum mortgage amount a home buyer may qualify for using FHA financing.  Using the current median home price for California, under the current FHA rate the MMI would be $123 per month; when the new premium goes into effect later this year the MMI will be $335 per month.  If the income for the median home buyer is $5000 per month, the increase in MMI per month equals 4% of their gross income.  Basically the FHA buyer with $5000 per month income will lose 4% in purchasing power due to the pending change in mortgage insurance.

Rates for Friday June 18, 2010: Rates has a slow and steady week this week dropping 0.125% across the board.  From last June we are down from 1-1.5% across programs.

FIXED RATE MORTGAGES AT COST OF 1 POINT*

30 year conventional 4.375%                            Down 0.125%

30 year conforming-jumbo 4.625%                   Down 0.125%

30 year FHA    4.25%                                      Down 0.125%

30 year FHA jumbo 4.625%                            Down 0.125%

Please note that these are base rates and adjustments may be added for condominiums, refinances, credit scores, loan to value, and period rate is locked. 

Please note that rates quoted are based on average of several lenders for a purchase transaction with 20% down payment with an impound account for taxes and insurance and a minimum FICO score of 740; APR is not quoted as it is dependent upon specific loan amounts, lenders and services selected.  Numbers provided are for comparative purposes only.

First day of summer in our home as school ended yesterday—when does camp start?!?

Happy Father’s Day to the Dads out there, a special one to a Dad in San Francisco who taught me that integrity matters, a lot. 

Have a great week,

Dennis