Introduced in 2008, LLPAs compensate government-sponsored enterprises (GSEs) for differences in borrowers’ credit risk, including factors such as loan-to-value (LTV) ratio and credit score. Previously, the GSEs charged a fixed guarantee amount that did not vary depending on the borrower’s risk factors.
LLPAs can be paid upfront or built into the interest. But because mortgage rates are already high, there is often little or no room to absorb them, forcing borrowers to pay out of pocket. And that can derail transactions.
But cutting fees could impact GSE’s earnings. The American Business Institute estimates that Fannie and Freddie raised roughly $119 billion through prior LLPAs between 2014 and 2022, for an average of about $13 billion per year. Cutting it could boost volume but could hurt margins, especially as the Trump administration plans an equity offering for the GSEs.
“One of the core dilemmas in reforming the GSE is the conflict between their congressionally mandated mission and the financial need to generate sufficient return on equity (ROE) to entice private capital to replace the taxpayer guarantee,” said Isaac Boltansky, chief policy officer at Pennymac.
Undo recent changes
Over the years, LLPAs have been amended several times, sparking debate over whether they should promote affordability or merely reflect risk.
Under the Biden administration, some LLPA are changing higher prices for certain loans. A proposed fee tied to a borrower’s debt-to-income ratio above 40% was later withdrawn after opposition from state officials and industry groups.
Scott Olson, executive director of the Community Home Lenders of America (CHLA), said any changes to LLPAs should target areas where fees have the greatest impact, particularly on entry-level home purchases.
CHLA supports eliminating the 75 basis point fee for condominiums, the 50 basis point fee for manufactured home loans, and LLPAs for high balance loans.
Olson added that the CHLA was “not happy” with the increases in investment properties and second homes during the Biden administration, a decision that was made “not based on risk, but on the intent to get Fannie and Freddie to make fewer of these loans.”
But there is an affordability component to these two areas, as investment properties often provide affordable rental housing, while second homes play a key role in many local economies, including coastal areas, he added.
Boltansky agreed that reversing some Biden-era changes could make the price grid more reflective of actual risk. But he warned against cutting fees for investment properties, second homes and payouts.
“These segments already benefit from a deep and robust private-label securitization market capable of attracting sophisticated capital,” Boltansky said. “Reducing LLPAs on these loans would actively crowd out private liquidity, unnecessarily expanding the government’s footprint into a sector that is already functioning efficiently and without taxpayer support.”
Keep it simple
Bob Broeksmit, president and CEO of the Association of Mortgage Bankers (MBA), said if the focus is on cutting LLPAs where it matters most, relief should focus on interest rate and term refinances and across-the-board cuts in purchase loans.
“For a rate-and-term refinance where the borrower has an on-time payment history – let’s say, within the last 12 or 18 months – and they refinance to lower their payment, they have already proven their creditworthiness at the higher payment amount,” Broeksmit explains. “That LLPA could be eliminated, which would increase the benefit to the borrower.”
Broeksmit said the focus on the rate and term refinancing is due to the fact that with payout options “the risk to the GSE is higher than they currently have on their books” because it entails larger loan amounts and higher LTV ratios.
“On the purchasing side, the most direct and easiest way to make a change would be a reduction across the board,” Broeksmit said. “I don’t know what size; we’ll leave that up to the FHFA and the GSEs.”
According to Broeksmit, simple and broad adjustments can quickly have a positive effect on affordability. But deep, nuanced change is more complicated to implement and can have varying impacts on borrowers depending on where they are on the risk spectrum.
Should risk be central?
Mortgage brokers also want relief for second homes and high-balance loans – which are above the baseline standard but still qualify for GSE purchase in high-cost areas.
“If we see an improvement there, we could compete in that area as we did before,” said Brendan McKay, chief advocacy officer at the Coalition for Broker Action (BAC). “I hope these changes do not come at the expense of product prices for first-time homebuyers or underserved communities.”
McKay said that since the changes in the Biden administration, rates on second homes have been about 50 to 75 basis points higher, while high-balance loans are also seeing rates up to three-quarters of a point higher than standard GSE products.
McKay supports risk-based pricing, but says it shouldn’t be the only consideration.
“Fannie and Freddie are incredibly profitable,” he said. “If they continue to behave in an intelligent, risk-based way while helping improve housing in this country, that’s great.”
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