March 31 - Although we do not normally talk much about the intricacies of the mortgage market, momentous things have been taking place over the past two weeks which are likely to have a knock-on effect on the housing market. For more details we refer you to a well-written article by Dan and Barry Habib and published at the mbshighway.com web site.
Unintended consequences of actions taken by the Federal Reserve are making life very tricky for mortgage lenders and mortgage service companies. Many of them will struggle over the coming weeks and home loans may become much more difficult to obtain. Housing demand is falling sharply anyway, and this has the potential to drive it even lower.
So what has gone wrong? It is complicated, but in a nutshell:
- Far more home loans are being paid off after a very short time because refinancing is very popular when rates are low. This is a problem for mortgage service companies because it causes them to lose money. They typically pay 1% up front for the right to service a loan, and if it has a life of less than 3 years they never recoup those up-front costs
- Job losses caused by COVID-19 mean far fewer new home loans are being created. They also mean the mortgage service company may not receive the monthly payments they are expecting for the loans they service. They have a responsibility to make the payments to the owner of the loan even though they have not received anything from the borrower.
- The government has unilaterally granted forbearance for borrowers if they are unable to make their mortgage payments due to the pandemic. This applies even if they have not yet made the first payment on the loan. This makes the loan a disaster - the lender cannot sell a loan which is delinquent on the first payment date. They must hold on to the loan which ties up their available credit.
- Many mortgage service companies finance much of the 1% they pay for the right to service loans. The value of loan servicing has been slashed in half overnight so these service companies are facing margin calls.
- Many loans in process have rate locks. Borrowers have been breaking those locks in the expectation that when the Fed Funds Rate dropped from 1% to zero, mortgage rates would also drop by a similar amount. The world does not work like that. However mortgage lenders hedge their rate locks by shorting Mortgage Backed Securities. The Fed is buying a huge amount of MBS paper driving the prices up sharply. The lenders short position is creating big losses for the lenders for locks that the borrower has broken anyway. The lenders are throwing money away to give locks the borrowing did not use. Not good for anyone.
Life for lenders is very difficult right now so they are having to increase rates rather than lower them, and they are still losing much more money than they planned in ways they never anticipated. They cannot handle the quantity of refinance loan applications they are receiving so they are raising rates in an attempt to slow down applications. The markets for new government loans, jumbo loans and anything that does not fit ideal parameters have all but dried up.
So the result is the opposite of what the government intended. Instead of home loans getting cheaper and easier to obtain, they are getting more expensive and harder to obtain. At least they are until someone steps in and sorts this mess out.
As if things weren't bad enough.
(Information provided by The Cromford Report)
