Mortgage giants Fannie Mae and Freddie Mac (known as Government Sponsored Enterprises, or GSEs) don’t issue mortgages directly. Instead, they buy certain mortgages originated by other lenders and bundle them into mortgage-backed securities that are then sold to investors. Critically, these securities are guaranteed against default by Fannie and Freddie, protecting investors and making the securities more attractive. That guarantee enables long-term mortgage products like fixed, 30-year loans to be made widely available at lower rates.
But Fannie and Freddie have been under conservatorship of the federal government since 2008, which means those guarantees are largely backed by U.S. taxpayers, not private capital. Because Fannie and Freddie play such an outsized role in mortgage finance in this country, one of the longstanding legacies of the recession is that taxpayers today back a large majority of the nation’s mortgage market. Fears around the degree to which taxpayers would be on the hook if the market soured have kept Fannie and Freddie in Congress’ crosshairs.
Hoping to reduce taxpayers’ risk, policymakers are considering changing the guarantee, which may lead to a shift toward adjustable-rate products, higher fixed interest rates and/or shorter-duration loans. Those opposed to curtailing the government’s guarantee argue that without it, today’s 30-year fixed-rate mortgage could change drastically – to borrowers’ detriment.
What exactly would lending – and, critically, borrowers’ monthly costs – look like without the venerable 30-year, fixed-rate mortgage that has become the bedrock of housing finance? The Bureau of Labor Statistics estimates roughly seven in 10 mortgages held in 2014 were 30-year fixed-rate.
The figures below provide a glimpse at mortgage alternatives, and illustrate how sensitive house payments are to changes in interest rates and loan duration (use our comparison tool to see the differences across metro areas).
30-Year Fixed-Rate Mortgage, at Current Rates
- The most common mortgage product today is the 30-year fixed rate mortgage. Last month, to buy the typical U.S. home with a 30-year fixed rate mortgage, the monthly payments would be $777, or 15 percent of the metro’s median income.
Adjustable-Rate Mortgage, at Current Rates
- If the terms of 30-year fixed-rate mortgages become less favorable after GSE reform, more buyers could choose adjustable-rate mortgages (ARMs). While ARMs often provide a better deal for the first few years of the loan, rates and payments eventually increase unless a borrower refinances. Last month, to buy the typical U.S. home with an adjustable rate mortgage, the first year’s monthly payment would be $736 or 15 percent of the metro’s median income. But those payments would rise when the adjustment takes place.
Non-Conforming Jumbo Loan, at Current Rates
- Another possibility as a result of GSE reform is that interest rates could climb in response to the elimination of a government guarantee. We don’t know how much they might climb, but they could resemble rates on current loans that don’t have a government guarantee: non-conforming, jumbo loans (a relatively small market currently skewed toward the wealthy). So the exact terms of today’s jumbo loans may not scale to the larger housing market. Last month, to buy the typical U.S. home with a 30-year, fixed rate, non-conforming jumbo mortgage, the monthly payments would be $797 or 16 percent of the nation’s median income.
30-Year Fixed-Rate Mortgage, at 7 Percent Rate
- Interest rates overall are at historic lows, but reforms to Fannie and Freddie in tandem with other trends in the economy could raise mortgages rates across the board. If they reach 7 percent, a rate common 20 years ago, monthly payments could rise substantially. Last month, to buy the typical U.S. home with a 30-year fixed rate mortgage common in the late ‘90s, the monthly payments would be $1,098 or 22 percent of today’s metro median income.
15-Year Fixed-Rate Mortgage, at Current Rates
- Even if rates remain similar to today, more buyers may shift toward shorter-term loans as a result of GSE reform and/or other economic shifts. While today’s 15-year, fixed-rate mortgages usually provide lower interest rates, the shorter time frame makes each payment larger. Last month, to buy the typical U.S. home with a 15-year fixed ratemortgage, the monthly payments would be $1,166 or 23 percent of the metro’s median income.
15-year Fixed-Rate, Non-conforming Jumbo Mortgage, at Current Rates
- Finally, it’s possible that rates rise and buyers move toward shorter-term loans. In that case, new loans could resemble 15-year, fixed-rate, non-conforming jumbo loans. Last month, to buy the typical U.S. home with a 15-year fixed rate non-conforming mortgage, the monthly payments would be $1,210 or 24 percent of the metro’s median income.
We don’t know what exact effects, if any, GSE reform might have on the 30-year mortgage. It’s possible any resulting dominant mortgage product would be wildly or only mildly different from what we have today. The figures in the comparison tool above provide a glimpse at mortgage alternatives and illustrate how sensitive house payments are to changes in interest rates and loan duration.
If monthly payments soar and stay elevated, at some point we’d expect home prices to fall in response to this decreased purchasing power. However, while some households may be able to absorb the extra borrowing cost, in the nearer term first time homebuyers or buyers on the margin could feel a real pinch as homeownership becomes less affordable.
Source: forbes.com ~ By: Svenja Gudell