Freddie Mac Plans to Offer New Second Loans
The Federal Housing Finance Agency (FHFA) has made a new proposed rule that would allow the Federal Home Loan Mortgage Corporation (Freddie Mac) to purchase certain single-family closed-end second mortgages. The plan is the result of concerns regarding the impact of current, higher interest rates on existing homeowners, which provides limited options to access equity.
As FHFA stated in their proposal, “[f]or the many homeowners who purchased or refinanced their homes during a period of lower mortgage rates, a traditional cash-out refinance today may pose a significant financial burden, as it requires a refinancing of the entire outstanding loan balance at a new, and likely much higher, interest rate. Homeowners may also use second mortgages to access the equity in their homes. For a second mortgage, only the smaller, second mortgage would be subject to the current market rate, as the original terms of the first mortgage would remain intact. Moreover, second mortgages are typically offered at a lower interest rate than some financing alternatives such as consumer or personal loans.” To mitigate these issues, Freddie Mac proposal would create an avenue for lenders to sell these close-end second mortgages on the secondary market, providing a lower cost alternative to a cash-out refinance in higher interest rate environments.
According to the Urban Institute, this new approach could offer substantial savings. For example, a homeowner with a $300,000 mortgage at a 3% interest rate might face a monthly payment of about $1,265. If their home value has increased to $500,000 and they wish to borrow an additional $100,000 for improvements, refinancing at the current rate of 7.25% would raise their monthly payments to approximately $2,729. Freddie Mac’s new plan, however, allows this borrower to keep their existing payment and take out a new 20-year mortgage for the extra $100,000, adding only $965 per month, resulting in a total monthly payment of $2,130.
Despite these potential benefits, Michael Bright, CEO of the Structured Finance Association and former president of Ginnie Mae, has voiced concerns about the broader implications of this policy. Bright argues that government-backed second mortgages could introduce several risks.
Firstly, he warns that increased consumer spending, encouraged by equity extraction, might exacerbate inflationary pressures, counteracting efforts by the Federal Reserve to manage inflation. Secondly, by making it easier for homeowners to access equity, this policy could further constrain the housing supply. Homeowners who extract equity might be less inclined to sell their properties, intensifying the existing supply crisis.
Bright also raises concerns about the financial risks borne by taxpayers. With the government backing these second liens, there is a risk that taxpayers could face significant financial exposure if borrowers default on their loans.
In summary, if Fannie Mae does choose to move forward in purchasing second mortgages it will provide homeowners with more flexible financial options. The greater economy and housing market will likely be impacted if this occurs. In particular, the housing supply will likely continue to be limited and the challenges for buyers, especially first-time buyers, will continue.