A Free Lunch?

Some mortgage folks are stumping for a free lunch. Are they right?

Some analysts have made waves by advocating for changes in the mortgage market. If Fannie and Freddie ease some of their underwriting requirements—just for refis, and just for households that already have a government mortgage—it could yield a consumer windfall of up to $50 billion, and it wouldn’t directly cost the taxpayers a dime.

Here’s how it would work. Currently, when a homeowner wants to refinance a conventional mortgage, he has to have a qualifying home value, income, and credit report. After passing all three tests, the borrower can refinance via the government agencies. It makes sense to re-approve the loan because Fan or Fred package it up and sell it to the market, guaranteeing the principal. What has them in hot water is loans they’ve guaranteed that have since gone bad. What if they relaxed their underwriting criteria for existing borrowers—ones whose mortgage the Feds already guarantee?

It wouldn’t mean any more credit risk: they’re already on the hook for the principal. If the borrower’s a bad risk, they’d actually be helping themselves by reducing the payments. The average consumer could save about $2500/year—real money. Who loses? The owners of high coupon mortgage pass-through bonds; investors reaping a windfall now due to lower than expected refis.

But there’s no free lunch. Changing the rules of the mortgage market in mid-stream could have unforeseen consequences down the road. But we’re going to change the rules dramatically for home finance pretty soon anyway. This way, consumers get a break. Heaven knows they need one.

Douglas R. Tengdin, CFA
Chief Investment Officer
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