An influential government-related mortgage investor active in the first-lien market could become a purchaser of some
Freddie Mac would actively buy some closed-end second liens if it holds the first mortgage under a proposal
The proposal is a new take on something Freddie dabbled in decades ago, though in the prior instance such loan purchases came to a nonmaterial amount. This time around, the loans would be positioned as an alternative to cash-out refinances that have become uneconomic for the many older loans originated at lower-than-current-market rates.
"The proposed activity is intended to provide homeowners with a cost-effective alternative for accessing the equity in their homes," said FHFA Director Sandra Thompson in a news release.
It also could have synergies with housing programs like Freddie's
Stakeholders will have 30 days to comment on the proposal. The FHFA will decide whether to move forward with the proposal within the subsequent 30 days, with the pending federal election in November likely adding some urgency for quick decision-making on the issue.
The concept outlined addresses a specific need inherent in the composition of the current market but how receptive the mortgage industry will be to it may depend on some yet-to-be specified details.
"I think it's an interesting point in time where cash-out refinances don't pencil out from the consumer perspective," said Pete Mills, senior vice president of residential policy and member engagement at the Mortgage Bankers Association.
The extent to which it addresses that challenge may depend on what Freddie Mac will offer for the second lien it buys and what any associated loan-level pricing adjustments are like, something the comment period may shape.
"We haven't seen pricing or LLPA grids, or anything like that, so it's a little early to tell, but I guess the important thing here is that's sort of the point of the new activity process," Mills said.
How depositories respond to the concept remains to be seen. To a degree, closed-end seconds compete with HELOCs, but generally holding the former in portfolio is not attractive to banks, for whom lines of credit are a better match with their deposits. Some nonbanks may sell closed-end seconds to the private secondary market but it's considered a limited market.
"Certainly that will be part of the discussion in the comment process around what market need is this serving?" Mills said, referring to one of the points raised in a series of questions the FHFA suggested commenters address.
As a government-sponsored enterprise, Freddie Mac may be able to provide at lower-than-market rates for closed-end seconds, particularly if it can eventually amass enough product for securitization and manage the loans' risks without making too many pricing adjustments for them.
These loans by nature are riskier than first liens given their subordinate position, but Freddie does propose some guardrails aimed at protecting their performance. These include 20-year fixed rates, a fully amortizing structure, and loan-to-value ratios limited to 80% or 65% for manufactured homes.
"Credit risk transfer opportunities would be evaluated in subsequent phases," the proposal also noted.
Land trust and cooperative share loans would not be eligible. The representation and warranty framework would be independent from that of the first mortgages.
Even within limits on primary loan type, the combined LTV and other factors, the volume could be considerable, particularly if both Freddie and its larger competitor, Fannie Mae, were to become active in this area, Bank of America researchers wrote in a report Wednesday.
"For mortgages owned by the two GSEs, equity extraction could be as much as $1.8 trillion on sub-4% mortgage loans, keeping the CLTV below 75%," they said.
Closed-end seconds may pose less risk for Freddie than cash-outs and put more decisions about distressed loans in its hands as opposed to a servicer's, according to the Bank of America researchers.
"Freddie Mac would have a lower credit first on a combined low first-rate lien and a high rate second-lien than a high-rate cash-out refi loan partly due to the shorter term on the second," they said. "Having ownership of both the first lien and the second lien mortgage would allow Freddie Mac to have better control over loss mitigation policies."
The proposal appears aimed at keeping the servicing somewhat in line with that of first mortgages, with loss mitigation and foreclosure activities for all the loans requiring Freddie Mac approval. If the first lien is refinanced, the second must be paid off absent any jurisdictional legal prohibitions against it.
The seconds would be manually underwritten and sold outright through the cash window in limited quantities to start. They wouldn't immediately be eligible for forward delivery or the to-be-announced market. They'd be held for six to nine months until non-TBA securitizations could be established.
Freddie would eventually aim to provide automated underwriting for the home equity loans.
