One of the safest and most comforting terms in real estate has to be the so-called “conforming” loan. It “conforms,” and therefore it must be the type of financing that everybody wants. And, indeed, conforming loans are a financial joy. They’re mortgages that meet the standards and guidelines established by Fannie Mae and Freddie Mac, loans without surprise features, hidden costs or an array of “gotcha” clauses.
But there’s a twist buried deep inside the system that makes conforming loans so comfy. There are hidden costs that homebuyers shouldn’t have to pay; at the very least, they’re costs that should be much lower. These costs are the so-called “guarantee fees” or “g-fees” that Fannie Mae and Freddie Mac assess when they purchase mortgages from lenders.
G-Fees a Hidden Tax on Homebuyers?
As described on the Federal Housing Finance Agency website, the way it works is this: Fannie Mae and Freddie Mac buy single-family mortgages from lenders, who receive mortgage-backed securities (MBS) in exchange. Fannie Mae and Freddie Mac then charge a fee to guarantee the payment of principal and interest on their MBS. This guarantee fee (g-fee) covers projected credit losses, administrative costs, and a return on capital.
In 2016, the average single-family guarantee fee was 57 basis points. In other words, a lender who sold a mortgage to Fannie Mae or Freddie Mac last year could expect to pay about $570 per $100,000 for the privilege.
As you can imagine, lenders are not delighted with the thought of paying such costs and gleefully pass them along to borrowers in the form of higher fees and charges. You can see this process at work when comparing the costs for conforming loans and jumbo financing.
Jumbo mortgages are loans that have balances above the limits allowed by Fannie Mae and Freddie Mac. Because they don’t meet these guidelines, jumbo mortgages are examples of “non-conforming” loans. Fannie Mae or Freddie Mac can’t buy this type of financing, and therefore, if doesn’t face the cost of guarantee fees.
Now it might seem that a conforming loan is so risk-free that the cost of such financing would be lower than a jumbo mortgage, but that’s generally not the case. For example, for the last week in October 2017, the interest rates on conforming loans were 4.18%, while jumbos could be had for 4.11%, according to the Mortgage Bankers Association.
“Historically, g-fees were used to provide some of the funds that Fannie Mae and Freddie Mac needed to function,” said Rick Sharga, executive vice president at Ten-X.com, the online real estate marketplace. “But in practice today, g-fees appear to be more like a ‘hidden tax’ on homebuyers, since the funds go directly to the U.S. Treasury. If the government is looking for ways to improve affordability—especially for first-time buyers—it might be time to think about lowering g-fees.”
G-Fees and the Third Amendment Sweep
The reality is that g-fees no longer go to support Fannie Mae and Freddie Mac. To understand why this is, we have to look at two dates.
First, in 2008 Fannie Mae and Freddie Mac were placed into a government conservatorship. Whether there was ever a need to take over Fannie Mae and Freddie Mac is a matter of dispute, one currently in the court system.
Second, in 2012 the Department of the Treasury established what it called a “Third Amendment sweep,” under which it claimed the right to keep all the profits from Fannie Mae and Freddie Mac. The government said that it was acting within its authority to lay claim to these revenues, but not everyone agrees.
While many on Capitol Hill loudly swear that they will never raise taxes, that is precisely the effect of the Third Amendment sweep. It takes money collected by Fannie Mae and Freddie Mac—money that comes from borrowers to support the mortgage system—and instead uses the cash to pay Uncle Sam’s bills.
We’re not talking about small sums. According to Pro Publica, Fannie Mae received $116 billion in federal bailout money, and so far, the government has gotten back $163 billion. Freddie Mac got $73.3 billion and the government has collected $108 billion to date. So far, the government has collected a profit of $83.2 billion from both companies. (And maybe more: there’s a dispute regarding how much the government actually advanced to both companies and whether such funds were needed.)
Instead of raising taxes through Fannie Mae and Freddie Mac, why not reduce g-fees? That would lower the cost of real estate financing, thus making homes more affordable at a time when affordability is a serious issue for millions of potential buyers. And if the Treasury needs more money, there’s a simple and direct way to get it: Just march up to Capitol Hill and ask Congress to raise taxes…