Executive Summary
In December, Congress passed the Temporary Payroll Tax Cut Continuation Act of 2011, which extended the 2 percentage point payroll tax "holiday" of 2011 into the first two months of 2012. However, to offset the nearly $20 billion cost of the payroll tax cut extension (along with a few other provisions), Congress adjusted the so-called guarantee fee charged by Fannie Mae, Freddie Mac, and the FHA, mandating that the fee must rise by at least 10 basis points. The new g-fee increase is set to apply beginning on April 1, 2012 (no fooling!), and its effects are already being felt as borrowers look to set 45- and 60-day rate lock guarantees on current purchases and refinances. The net impact to clients: if there's a purchase or refinance being considered, it could be worth many thousands of dollars to get the loan done as soon as possible.
The inspiration for today's blog post are some alerts I've begun to receive from my mortgage broker friends, warning of pricing shifts that are starting to become apparent on longer rate-locks for pending borrowers as the April 1st effective date for higher guarantee fees approaches.
What are these so-called "g-fees"? They're an increase to the stated interest rate on mortgages charged by the government-sponsored entities (Fannie Mae and Freddie Mac) that are used to back the guarantees those organizations provide for buyers of mortgage-backed securities. In other words, when Fannie Mae or Freddie Mac buy up mortgages from originators and repackage them into mortgage-backed securities that investors buy, the g-fee surcharge from Fannie and Freddie that is layered into the loan is collected by the entities and used to pay off investors in the event the loan defaults.
The guarantee fee structure is not new. It has been in place for decades, and is part of the fundamental structure for Fannie and Freddie to be able to provide the liquidity they do in the mortgage marketplace. In 2011, the average g-fee charge was about 26 basis points. With the new rules under the Temporary Payroll Tax Cut Continuation Act of 2011, the average fee must rise to at least 36 basis points (although it can be raised higher, too).
How does this translate for borrowers? Right now, a homeowner who was going to refinance and get a 4.0% interest rate was really paying a rate of about 3.75%, plus a 0.25% g-fee (give or take a little). The cost of the g-fee is not separately stated when the loan is taken out; it's simply built into the underlying interest rate offered in the first place. With the new g-fee, this same client would face an interest rate of 4.1% - or in reality, 4.125%, since mortgage rates are always quoted in 1/8ths.
Paying an extra 1/8th of a point over the life of a loan is not trivial, though. An interest rate increase from 4% to 4.125% on a $200,000 mortgage will result in a payment increase of over $14/month, which translates to more than $5,000 of additional cost over the life of the mortgage. A $400,000 mortgage would face over $10,000 of additional fees paid over the lifetime of a 30-year amortizing loan.
As critics have noted, this cumulative g-fee cost pales in comparison to the few hundred dollars the average taxpayer will save with a 2-month extension of the payroll tax cut, effectively forcing the payroll tax cut for the masses to be funded on the backs of the relatively fewer number of people purchasing homes or trying to refinance their existing homes. On the other hand, Fannie Mae and Freddie Mac are currently experiencing significant losses on their mortgage portfolios, which are being passed through to taxpayers, in part because historical g-fees were too low for the magnitude of mortgage defaults experiences over the past several years. So some lawmakers simply view this as a necessary step to wean Fannie and Freddie off of government support and try to make them independently viable again, with a g-fee that is appropriately matched to the risk the mortgage giants face. In other words, the hope is that with the higher g-fees, Fannie and Freddie will now be charging a sufficient fee for the guarantee they provide, so that they will never again have to rely on taxpayers down the road.
So what does all this mean for financial planning clients? Those who have been considering a refinance may wish to act quickly to get the refinance done before the new g-fee passes through the mortgage system entirely. Of course, in the end it's only 10 basis points (perhaps rounded up to 1/8th of a percent); if a client still has strong views that rates are heading significantly lower on the back of continued efforts by the Federal Reserve to stimulate the economy, or perhaps due to a potential credit crisis in Europe, it may still ultimately be better to wait. But for clients who are agnostic about the direction of rates, or outright fear they're heading higher soon, and might have been considering a refinance anyway, now's the time. Although the new g-fees take effect on April 1st, brokers are seeing the fee increases pass into the rate structure already, especially for longer rate locks on loans that wouldn't be settled, pooled, and securitized by the deadline, so the time window is closing fast. Those who are seeking to borrow funds for a new home purchase may already be too late, although if the property is closing soon, there may still be time to get the loan done on the current g-fee structure.
Notably, the new g-fees also apply to FHA loans, and apparently will apply to the ongoing 1.25% (now soon to be 1.35%) mortgage insurance premium wrapped into reverse mortgage loans as well. The higher g-fees for all applicable loan types are scheduled to apply through October 1, 2021. Although technically borrowers can avoid the g-fee by financing with lenders who do not plan to resell the loans (and therefore don't need them to conform to Fannie or Freddie standards or submit themselves to the g-fee), the reality is that the overwhelming majority of the marketplace continues to finance through government-sponsored entities (and/or the alternative may be no g-fee, but a rate that is even higher simply because of the rate of return that the private lenders require).
So the bottom line is that if you're working on a purchase or thinking about a refinance for a client, the time is now to get the loan done if you hope to help the client avoid the looming new g-fee. It may only be 10 basis points, but over the lifetime of the loan it can still add up to some real dollars.
Well stated Michael. The fee increase will be absorbed into the pricing structure of a mortgage just as the price of fuel is priced into a gallon of milk. Thankfully rates remain at historically low levels… which helps cushion the blow.