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Are we facing the end of the 30-year fixed-rate mortgage?

Many housing proponents say the government's move to dismantle Fannie Mae and Freddie Mac means the most popular home loan will be more expensive. But how much more is a matter of debate.

May 15, 2011|By Lew Sichelman
  • With the demise of Fannie Mae and Freddie Mac, some housing interests fear the passing of the 30-year fixed-rate loan.
With the demise of Fannie Mae and Freddie Mac, some housing interests fear… (Francine Orr, Los Angeles…)

Reporting from Washington — Will the move to dismantle Fannie Mae and Freddie Mac mean the end of the 30-year fixed-rate mortgage as we have come to know it?

Many housing proponents say that it will. Without the government's backing, they contend that the 30-year mortgage will become a relic of a bygone era when mortgage money was cheap and easy to come by. But others say America's most popular home loan will still be available — if you can afford it.

Before digging deeper into the debate, a short primer: Although the long-term fixed-rate mortgage was born with the Federal Housing Administration — the government agency established in 1934 to help stabilize the then-shaky housing market — it was taken to its greatest heights by Fannie and Freddie, the two government-chartered institutions that were created years later to keep the money flowing for home loans.

These government-sponsored enterprises (GSEs) live and work in the secondary mortgage market, where they keep primary lenders flush with cash by buying their loans and packaging them into securities for sale to investors worldwide.

With their implicit government guarantee and their corresponding ability to attract cash even though they were offering a lower return than investors could earn elsewhere, the GSEs were, in effect, able to subsidize the 30-year mortgage, making it less expensive than it would have been otherwise.

That such government-backed loans are cheaper is evidenced by the difference in rates charged in the so-called jumbo sector, where mortgages in amounts above the legislated ceiling are off-limits to Fannie Mae and Freddie Mac. (The limit is as high as $729,750 in some markets. It is due to fall back to $625,500 on Oct. 1.)

According to HSH Associates, a mortgage information service, the spread between loans that conform to Fannie and Freddie's limit and those that are over it is 54 basis points. (A basis point is 1/100th of a percentage point.) But the gap was as wide as 180 basis points as recently as December 2008.

The long-term fixed-rate mortgage that meets the two GSEs' rules also comes with a bonus, a no-cost prepayment option. Borrowers can trade them in at no cost for even less expensive loans when market rates fall or otherwise pay them off without penalty.

Normally investors shy from buying loans with this feature — or demand higher yields — because there is no way of knowing when borrowers will pull the plug. But because Fannie and Freddie guarantee that investors will be paid even if borrowers fail to make their payments, the loans are considered so safe that they are worth the prepayment risk.

Because of these key features, the 30-year home loan purchased by the GSEs has been the backbone of the housing market. There are no hard figures, but Jay Brinkmann, chief economist at the Mortgage Bankers Assn., says "essentially almost all" long-term fixed-rate mortgages at or below the conforming loan limit end up at Fannie or Freddie because of their superior pricing.

Now, though, the Obama administration, with the cooperation of Republicans, would gradually wind down Fannie and Freddie until they are mere figments of their former selves, if they survive at all. And with their demise, some housing interests also fear the passing of the 30-year fixed-rate loan.

If it doesn't go away, it will certainly be more expensive. How much more expensive is pure conjecture at this point, but some people predict that the rate could shoot up 3 percentage points.

The cost of a 30-year fixed-rate mortgage is hovering around 5%, so a 3-point jump would boost the rate to 8% or so, driving the monthly principal and interest payment on a $200,000 mortgage to $1,468 from $1,074. That's a difference of $394, a backbreaker for many would-be borrowers.

However, others say the increase in the rate won't be nearly that much. And once the mortgage market calms down, the difference may not be much at all.

"Three [percentage points] might be a knee-jerk reaction," says Keith Gumbinger of HSH. "But over time, it will probably settle in at a point higher or a little more. It's going to be a well-written mortgage anyway, so there won't be that much credit risk" for investors.

Three percentage points sounds "way too high," even to Brinkmann of the Mortgage Bankers Assn., which is pushing Capitol Hill for some sort of government guarantee on the safest, top-quality mortgages. Without that, the association argues, investors won't buy U.S. mortgages at any price.

But Edward Pinto, a resident fellow at the American Enterprise Institute, a conservative think tank, says the 30-year fixed-rate mortgage without any prepayment penalty — the kind of loan for which most borrowers opt — would cost only 1 percentage point more than it does now. At 6%, the monthly payout on $200,000 loan would be $1,199 a month, or $125 more than the same loan at the going rate now.

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