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Debate on housing restart raises questions over 30-year fixed-rate mortgages

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Lawmakers continue to inch toward a new structure for housing finance in the U.S., one that may conceivably herald the end of the hugely popular 30-year, fixed-rate mortgage. The Senate Banking Committee heard conflicting testimony Thursday about the issue. Without some form of Fannie Mae and Freddie Mac, replacements to support these popular loans, many first time borrowers will be shut out, said Janis Bowdler, senior policy analyst at the National Council of La Raza. "Without that guarantee lenders would not offer 30-year fixed-rate mortgages, at least not at rates the average person could afford," Bowdler said. "Yes, some would be available but not for the average family but for those with a large amount of inherited wealth they can put to a large down payment." Others dared to unravel the nearly divine consumer sentiment toward the product. Anthony Sanders, a professor of finance at George Mason University, pointed out volatile interest rates – as the market is currently experiencing –  actually threaten FRMs more than adjustable-rate loans because of massive refinancing waves – which the market is also currently experiencing (see the chart below Sanders provided). "As interest rates rise and fall, mortgage origination volume is subject to massive swings. Mortgage originators and servicers have significant costs associated with managing such volatility," Sanders said. "Volatility in pricing also makes mortgage shopping more difficult for borrowers in that mortgage prices can vary significantly on a daily (or even intraday) basis." Paul Willen, senior economist at the Federal Reserve Bank of Boston, said of the $2.6 billion worth of foreclosures he studied during the crisis, 88% suffered no payment shock. "The mortgage they made when they defaulted was exactly the same as the initial payment. Of those 59% of them had a fixed-rate mortgage. That alone should diffuse us of thinking the FRM is the safest of all mortgages," he said. While he did say FRMs suffered lower default rates when compared to ARMs, he pointed out different borrowers take out these adjustable loans as they speculate on the property.With that considered, ARMs holders are more likely to default if they experience a negative event such as divorce, illness and especially job loss. This default risk increases even more if the mortgage is in negative equity. John Fenton, president and CEO of Affinity Federal Credit Union, said without a doubt people of all backgrounds come to his bank preferring the 30-year FRM. He was concerned that if lawmakers cut too much of the government support for these loans, larger lenders with better access to capital market funding would hold an even larger advantage than they already enjoy. "The 30-year fixed-rate mortgage remains the most popular. The ability of credit unions to write these loans and hedge the interest rate risk through the capital markets is crucial to a competitive mortgage finance system," Fenton said. ARMs have a built-in safety valve that lowers interest rates for borrowers as rates fall, a feature borrowers with FRMs have to "beg and plead with their servicer for a refinance," Willen said. But Susan Woodward, president of Sand Hill Econometrics, argued for preserving the stability of the FRM many consumers want. She said with interest rates already so low, the only direction to reset is up, which would strain already budget-strapped households. "We haven't seen the full force of when ARMs reset upwards," Woodward said. "It's much more likely they would go up because they cannot go down much further." One thing all of the panelists, Democrats and Republicans on the committee agreed on is that something should be done to help borrowers better understand adjustable-rate mortgages. Sen. Richard Shelby (R-Ala.) raised the point when he asked one panelist if there was any way Congress could foster clearer terms on ARM documents. The Consumer Financial Protection Bureau, the agency he and other Senate Republicans are currently blocking a director for, advanced plans for revamped mortgage documents to present borrowers a clearer understanding of the terms. In the end, any opinion on the future of the 30-year FRM, depends upon varying degrees of belief that the private market would shy away from such risk when Fannie and Freddie are wound down as Bowdler foresees or if lenders will return to meet the demand. "Once we get out of this rut," Sanders said, "lenders will start making these loans again." Write to Jon Prior. Follow him on Twitter @jonaprior.

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