mortgage loans when it becomes advantageous to do so,” according to the Vanguard Group, manager of $4.9 trillion in global assets. “The risk to MBS investors lies in the fact that exact prepayment amounts are not known in advance; risks are further- more associated with both increases and decreases in interest rates.” Lenders historically have sought to discourage refinancing and cur- tailments with prepayment penal- ties, sometimes very stiff penalties. Prior to the mortgage meltdown, Maine reported that, “prepayment penalties can be very expensive. For example, a typical prepayment pen- alty applies for the first five years of a loan and equals 5 percent of the loan’s balance. A lender enforcing such a clause would add $5,000 to the payoff amount owed by a con- sumer refinancing a $100,000 loan.” Some prepayment penalties went further. Before the meltdown there were “soft” and “hard” prepayment penalties. A “soft” prepayment pen- alty applied only to refinancing or curtailments. A “hard” prepayment penalty went into effect even in the case of a home sale, essentially forcing people to stay in place. The prepayment penalties of the time greatly worsened the mortgage crisis. A borrower could not refi- nance into a better loan because the soft penalty due at closing could be overwhelming – say $15,000 for a $300,000 mortgage. A hard penalty could prevent borrowers from mov- ing to get a better job or purchasing a home with lower costs. Prepayment penalties are now both rare and regulated. With mortgages backed by the VA and FHA – and with financing that meets Fannie Mae and Freddie Mac stan- dards – they are simply not allowed. Prepayment penalties are also not allowed with non-QM financing. In practice, the only place to find prepayment penalties today is with portfolio loans that meet QM stan- dards. With such financing, the pre-
payment penalty can equal as much as 2 percent of the outstanding loan balance prepaid during the first two years of the loan, 1 percent of the outstanding loan balance prepaid during the third year of the loan, and nothing thereafter. RISK & GUARANTEES “MBS,” explains FINRA, “carry the guarantee of the issuing organi- zation to pay interest and principal payments on their mortgage-backed securities. While Ginnie Mae's guarantee is backed by the ‘full faith and credit’ of the U.S. government, those issued by GSEs are not.” If the MBS originated by Fannie Mae and Freddie Mac are not gov- ernment guaranteed, then how are investors protected in the event of delinquencies and foreclosures? The answer is complicated. In ba- sic terms, a mortgage is secured by the credit standing of the borrower, the underlying value of the property, and a series of guarantees which emerge as the financing is originat- ed and sold. From the investor perspective, the risk-reducers include: First, the obligation of the lender to follow the Ability-to-Repay rule and verify the ability of the borrower to handle the debt. Lenders who sell loans that do not meet program or investor requirements can be forced to buy back mortgages. Also, under the False Claims Act, the Justice Department can go after lenders for treble damages and other penal- ties if they can prove that FHA-in- sured mortgages were improperly originated or underwritten. While borrowers routinely complain about excessive mortgage paperwork, lenders have strong incentives to play strictly by the rules and docu- ment every borrower claim. Second, the borrower is expected to put down 20 percent of the pur- chase price. Buyers who purchase for less will need some form of
third-party backing such as FHA, VA, or private mortgage insurance (MI) to reduce lender and investor risk. Lindsey Johnson, president of U.S. Mortgage Insurers (USMI), told Housing News Report , “because the credit risk protection from mortgage insurance attaches on the very first day the loan is originated, it trav- els with the loan wherever it goes, whether onto a lender’s balance sheet, to an investor, or into a secu- ritization pool. As such, private MI is one of the only forms of credit en- hancement that is compatible with a number of different housing finance reform proposals, including a pro- posal that relies on Ginnie Mae, a cooperative model or otherwise.” Third, the value of the property used to create a mortgage is deter- Because the credit risk protection from mortgage insurance attaches on the very first day the loan is originated, it travels with the loan wherever it goes, whether onto a lender’s balance sheet, to an investor, or into a securitization pool. As such, private MI is one of the only forms of credit enhancement that is compatible with a number of different housing finance reform proposals, including a proposal that relies on Ginnie Mae, a cooperative model or otherwise.” LINDSEY JOHNSON
36 | think realty housing news report :: june / july 2019
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