In April, the Federal Housing Finance Agency (FHFA) published a notice of a proposed new product from Freddie Mac to purchase certain closed-end single-family second mortgages. This notice represented the first time that a new product proposed by Freddie Mac or Fannie Mae (the Companies) was released for public comment under the process required by Congress and implemented through FHFA's โPrior Approval for Enterprise Products.โ regulationwhich came into force in April 2023.
Today, the FHFA issued conditional approval for Freddie Mac to participate in a pilot to purchase closed-end second mortgages. Before discussing the details of the proposal and the review process below, I would like to express my gratitude to the many organizations and individuals who provided comments, as well as the FHFA staff who reviewed these comments. By law, only 30 days are allowed for the public comment period, as well as 30 days after the public comment period for the FHFA to approve or reject the new product offering. While these are shorter periods than those associated with other public comment periods, I believe the process worked well and provided lessons for future new product proposals by the Companies.
The conditional approval was based on the numerous comment letters received, as well as considerations required by law:
- The product is authorized under specific sections of the Freddie Mac Charter Act.: The Freddie Mac Charter Act allows the company to purchase โresidential mortgages secured by a subordinate lien against a one- to four-family residence,โ subject to certain conditions (See 12 USC 1454(a)(4)). The proposed new product meets the requirements for authorization under the Charter Act.
- The product is of public interest.: As of December 2023, more than 95 percent of corporate-backed single-family mortgages had mortgage rates below current market rates, and most were at least 3 percentage points lower. Meanwhile, home prices nationwide have doubled in less than a decade, generating significant amounts of equity for many homeowners. Freddie Mac's purchase of closed-end second mortgages is intended to allow borrowers to keep their first mortgage at a low interest rate while accessing a portion of the equity in their homes. Several factors of public interest were considered in the review process:
- Provide lower-cost alternatives to existing cash-out refinance products.: Many borrowers โ particularly low-income borrowers and those in rural and underserved communities โ have had difficulty accessing equity in their homes through the private equity market. In a high mortgage rate environment, they are forced to give up their below-market rate and get a cash-out refinance with a higher mortgage rate for the entire loan balance or they are forced to sell their home when a problem arises. financial need. which can create instability for families and go against the missions of the Companies.
- Avoid displacing private capital or producing unwanted macroeconomic or mortgage market effects.: FHFA anticipates that a pilot with a volume limitation of $2.5 billion, a duration not to exceed 18 months, a maximum loan amount of $78,277 (as adjusted annually in Regulation Z), a minimum seniority requirement of 24 months for first mortgage, and eligibility for primary/primary residences only will allow analysis of consumer demand, lender offerings, servicer operations, and investor appetite in a controlled manner. The $2.5 billion volume limit, in particular, responds to several commentators' concerns about the potential macroeconomic and mortgage market impacts of broader supply. Some commentators cited estimates of $500 billion or more in second mortgage volume if Freddie Mac's proposal were approved, but the approved pilot volume cap instead represents less than half of one percent of these estimates. This is intended to mitigate any concerns about potential inflationary impacts, extending the mortgage โlock-inโ effect or the โcrowding outโ of private capital.
- Benefit Underserved Borrowers: FHFA anticipates that a pilot with a per-loan limitation of $78,277 (as adjusted annually in Regulation Z) will appropriately target rural and underserved borrowers. The average loan size for closed second mortgages is almost half the average loan size for home equity lines of credit (HELOC). Because borrowers in underserved communities (such as low-income borrowers or those in rural areas) have smaller balances, on average, HELOC providers may overlook these borrowers in favor of higher-income borrowers and others who currently They are well served by the real estate stock market. Therefore, a per-loan limit on closed-end second mortgages could potentially expand access to home equity products for underserved borrowers who would otherwise need to obtain a less affordable cash-out refinance or use other financing options. consumer credit with higher rates.
- Expand participation in the real estate securities market to smaller financial institutions that can effectively serve their local communities.: FHFA believes there are segments of lenders that have had difficulty accessing a secondary market for home equity products (HELOCs and closed-end second mortgages) outside of cash-out refinances eligible for sale to Businesses. Current home equity loans are primarily backed by larger depository institutions that tend to hold whole loans on their balance sheets, while home equity loan securitizations remain limited. FHFA is interested in whether this offering will be utilized by small community financial institutions that have more limited access to securitization markets. If so, this offering could support broader lending in underserved communities, while promoting greater competition among lenders and more choice for consumers. This will be one of many factors the FHFA will examine once the Freddie Mac pilot is concluded.
- The product is consistent with the safety and soundness of Freddie Mac or the mortgage financing system.: While the volume cap ensures that any second mortgages purchased through the pilot would represent a small fraction of Freddie Mac's total loan purchases, the FHFA also approved the limited pilot subject to additional safety and soundness considerations:
- Prices and capital treatment: FHFA expects that the pricing of eligible second mortgages, as well as the capital requirements associated with them, adequately reflect the risks they pose. This should also mitigate the risk of Freddie Mac crowding out activity that already exists in the real estate securities market, which is primarily focused on offerings to higher-income borrowers, as the goal is to reach borrowers who would otherwise be subject to more expensive alternatives, such as cash-out refinancing.
- Eligibility parameters: Additionally, as required for cash-out refinances purchased by Companies, the maximum combined loan-to-value ratio of the first and second mortgages cannot exceed 80 percent, ensuring a strong capital position for The borrower is protected against a drop in the value of the home. prices. And unlike a cash-out refinance, which for most borrowers in the current environment would involve resetting the entire mortgage balance at a higher interest rate, a second mortgage allows borrowers to keep an existing first mortgage with a low interest rate. In many cases, this would lead to a lower overall monthly mortgage payment compared to a cash-out refinance, thus improving the sustainability of the mortgage.
Finally, FHFA will use this inaugural new product proposal to find ways to improve the public review process for future business filings. While the length of FHFA's public comment period and review period are subject to legal limitations, FHFA remains open to additional ideas and comments from interested parties on ways to improve this process over time.
