Lenders React to Freddie Mac Policy Change Affecting 1% Down Programs

by Patrick Barnard
on August 16, 2017 1 Comment
Categories : E-Features

Freddie Mac recently updated the requirements for its Home Possible Advantage low down payment mortgage program by prohibiting lenders from applying gifts or grants directly to the 3% minimum down payment requirement.

As per a July 26 bulletin, the government-sponsored enterprise (GSE) is revising its requirements “to state that gifts or grants from the seller as the originating lender will be permitted only after a contribution of at least three percent of value (i.e., the lesser of the appraised value or the purchase price) is made from borrower personal funds and/or other eligible sources of funds as described in [the Freddie Mac Sellers Guide].”

The bulletin adds that “gifts or grants from the seller must not be funded through the mortgage transaction, including differential pricing in rate, discount points, or fees for individual loans or across the Home Possible offering.”

In other words, lenders can still offer “gifts” to assist borrowers with a down payment – it is just that those gifts cannot be rolled into the loan. The borrower must have a 3% stake in the transaction.

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So, was this a good move for the GSE to make?

Although some lenders profess that 1% down payment loans are a positive way to entice prospective buyers and stimulate the housing market and believe that gifts should be applicable to the down payment, others say they would prefer to see borrowers have more “skin in the game.”

“The more money someone has at stake in a transaction, the less likely they are to walk away,” Jeff Bode, president and CEO of Mid America Mortgage, tells MortgageOrb.

Bode says the change recently made by Freddie is really to address a “loophole” in the GSE’s guidelines for its Home Possible program that allows lenders to have their “gifts” applied directly to a borrower’s down payment.

“I don’t think [Home Possible] was really intended to be a one percent down program,” Bode says. “[Freddie Mac] just kind of had some loopholes with seller concessions that allowed [gifts to be applied toward the down payment].”

Bode says Mid America decided not to offer 1% down mortgages through Home Possible “because we never felt that it was [Freddie Mac’s] intention for it to be used that way.” He says because there was never any language in the guidelines prohibiting lenders from contributing cash “gifts” toward the down payment, they just went ahead and did it.

“I think this is something that just got stretched by creative lenders,” Bode says. “There wasn’t anything [in the guidelines] specifically precluding what these companies did. But, it just does not make sense for the GSEs to be putting … that’s just not a good quality loan to be making.”

Currently, numerous lenders, including Quicken Loans and Guaranteed Rate, offer 1% down programs. How the change in guidelines will impact these lenders remains somewhat unclear.

David Battany, executive vice president of capital markets at Guild Mortgage, which offers its own 1% down product, points out that the change does not take effect until Nov. 1.

“Quicken, Guaranteed Rate and other lenders were doing the Freddie Mac one percent program,” Battany tells Orb. “Freddie Mac announced that [its] selling guide allowance for mortgage lenders to provide down payment grants will be shutting down at the end of November. It is possible that lenders could still continue to offer Freddie Mac [1% down] loans that are closed and delivered up through that date – in which case, they would probably stop locking in new mortgages sometime in the early fall.

312582ab3e977efda76eb841e0228488 Lenders React to Freddie Mac Policy Change Affecting 1% Down Programs

“Freddie Mac will continue to do one percent down payment loans with two percent grants past the November cut-off date, as long as the grants are not funded by lenders and are instead funded by eligible third parties, such as nonprofit housing finance agencies,” Battany adds.

As Battany points out, Freddie Mac isn’t ending its 1% program, as some have characterized it, because it never actually offered a 1% down program to begin with. Rather, it is simply clarifying how it intends for the Home Possible program to be used.

“Freddie Mac’s selling guide allowed any lender to do a lender grant for a one percent down payment as long as the lender did not use premium pricing to pay for the down payment grant, meaning a lender could not increase the borrower’s interest rate to offset the cost of the down payment grant,” Battany explains. “In contrast, Fannie Mae’s guidelines require a mortgage banker to get a waiver in order to do a lender down payment grant.

“I don’t know why Freddie Mac [changed its guidelines], but it is possible they were concerned about an increase in the number of lenders wanting to roll out one percent down programs and the cost or difficulty in monitoring these lenders [to ensure they] were not increasing the interest rate to the borrowers,” he adds. “Fannie Mae also has a requirement that lenders cannot use premium pricing to offset the lender grant.

“I am not aware of any information that Freddie Mac has changed [its] views on the need to address down payment affordability,” Battany says. “They will still allow one percent down programs to continue, just not those funded by lender grants.”

As Bode points out, first-time home buyers have always had other avenues for coming up with a 3% down payment. For example, “You’ll always have parents who give gifts to help get their children in a house, to enhance the process, and I would do that for my own children, as well.

“But in this case, it’s going to take away from the thrill of a three percent down transaction,” Bode adds. “Frankly, if a lender does it, we’re getting paid to do that – we’re ratcheting up the price.”

Bode says the clarification from Freddie “was a good move.”

“We didn’t think it was a good loan to make; that’s why we didn’t chase it,” he says. “I don’t think we need to be taking advantage of the GSEs right now – they don’t have any capital – so why are we putting out a program that doesn’t make any sense?”

When asked if he thinks this might be a ‘“lead the way on credit policy”-type move, on Freddie Mac’s part, Bode says, “I don’t think that’s the case. I think this is just, when you see a mistake, you fix it.

“I really just think they wanted to fix an issue,” Bode adds. “And I think the [Federal Housing Finance Agency (FHFA), regulator of the GSEs] wouldn’t want that to be too aggressive. I wouldn’t be surprised to learn that the FHFA weighed in on this thing. Let’s put it this way: Had Mel Watt made the call, it would have been fixed.”

Arthur Prieston, chairman of The Prieston Group, which includes subsidiary PBIS and affiliate American Mortgage Law Group, says, “Ideologically, the FHFA is more inclined to support programs where the borrower has a significant-enough stake in the investment.” This ideological stance, he says, could have been part of the rationale for the change.

Prieston, who also serves as chairman of the Mortgage Collaborative’s newly formed capital markets committee, points out that the recent guideline change for Home Possible brings Freddie Mac “more in line with Fannie Mae and the Federal Housing Administration, which both have three percent programs.” This, he says, also could have been part of the rationale.

Another possible factor in Freddie’s decision, Prieston says, is that “there is growing interest amongst affinity groups to co-support down payment assistance programs.”

For now, lenders can still do 1% down loans using Freddie Mac and other loan programs.

But for some, including Bode, requiring a borrower to have at least a 3% “skin in the game” is simply good policy.

“I think as long as the government owns the GSEs, it should not go down the path for less than three percent cash into a home,” Bode says. “I think that’s probably where it should be – and as a citizen of the U.S., I think that’s probably appropriate.”

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Comments

  1. An important point to keep in mind when we think about how much skin in the game a buyer should have, is that a common 1% down program used to have a 99% LTV mortgage debt, so the borrower truly only had 1% equity in their property. In many of the programs discussed in this article, although the borrower is only paying 1% out of pocket, they have a 97% LTV, so they have 3% equity in their home on day one.

    If home prices were to increase by 5% over the next 12 months, then a buyer under one of these programs program today would have their original 3% equity, plus 5% equity from property price appreciation and an additional 1.65% equity from 12 months of amortizing mortgage payments. This puts the borrower at 9.65% total equity after 12 months. After 24 months the borrower would have 3.37% equity from their amortizing payments, plus their original 3%, for a total of 6.37% equity before any home price appreciation.

    If home prices were to increase 5% annually over two years, the borrowers would have over 16.37% equity by month 24. Once the borrower gets above 20%, which could be as soon as year three depending upon home price appreciation/depreciation, they can then request to have their mortgage insurance cancelled, which then reduces their monthly payment by potentially hundreds of dollars, and now they have a 78% or lower LTV loan with a low interest rate fixed for a total of 30 years.

    Nobody should assume home prices will rise annually, and they will always be cyclical, meaning they will also move down. However in many high cost markets, there is very little available housing supply, and it is possible that home prices will continue to appreciate for several years. Even with zero price appreciation, over five years, the amortization and initial 3% equity would put the borrower at 12.1% equity.

    Another benefit of some of today’s 1% down programs, is that the borrower can take the 2% that otherwise would have been used for down payment and keep these funds as cash reserves, so they are better prepared for any unforeseen life events, and this places them in an even stronger financial position.

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