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It’s Time to Prepare for Pushback on N/O/O and other “High-Risk” Mortgage Acquisitions

Blog By

Jim Glennon

Published March 11, 2021

In January, the Treasury and the FHFA released a statement outlining some proposed changes to the Preferred Stock Purchase Agreement for Fannie Mae and Freddie Mac. Among the changes was a provision proposing limits on the amount of “higher-risk” loans that the agencies can purchase in a trailing 52-week period.

The limits suggested in the announcement are percentages described as “current levels,” suggesting that the directive is to purchase loans in these higher-risk buckets at or below historical averages (i.e., do not increase the concentration of these loans). The stated proposed limits are:

  • Two or more of these high-risk characteristics: CLTV > 90%, DTI > 45, FICO < 680
    • Purchase transactions: 6% limit
    • Refinance transactions: 3% limit
  • Investment properties and second homes: 7% limit

In the last few days, we’ve seen a few aggregators overlay agency LLPAs, especially for the occupancy component of these changes, and Fannie Mae released a Lender Letter related to this announcement.  The letter does not state any new LLPAs or guideline restrictions (other than DU approval being required), but it may signal that the agencies are gearing up to monitor, and potentially penalize lenders who exceed the 7% limit on non-owner-occupied (N/O/O) and second home transactions, and it may be reasonable to expect upcoming changes to eligibility guidelines.

As luck would have it, the recent increase in rates has caused some lenders to originate more N/O/O and second home loans to backfill shrinking pipelines just in time for this issue to come to a head.

While it is possible that the new White House administration will seek to change some of the requirements in the January Treasury/FHFA announcement, for now, we should prepare as if these changes will stand.

How should we prepare?

A comprehensive approach is recommended to protect gains on locked loans and, as new loans are locked, confirm they are packed with excess margin to account for potential LLPA increases or other negative price effects down the road.

Lenders should consider prioritizing locked loans with N/O/O or second home occupancy for closing in the next few weeks. The agencies have not imposed new LLPAs yet, but some aggregators have. So far, bid prices do not seem to be factoring in a rush on N/O/O and second home loans, but they probably will at some point. Also, given the new requirement that all loans in this bucket be AUS approved, it is possible that approvals for these loans will become harder to come by.

Lenders should also contemplate continuing to build in extra margin and/or LLPAs for loans in these occupancy categories when pricing to LOs and borrowers. Again, downward price pressure for loans that fit this description is expected to pick up in the coming weeks/months, and so far, published LLPA changes vary widely – from no change to multiple points.  If you have not already overlaid LLPAs, 1-2 points would be a recommended place to start. Moving forward, you’ll also want to keep an eye on how much of your locked pipeline is N/O/O or second home loans.  Your hedge provider can offer you this data if you don’t have it available.

One other consideration: lock these loans best-efforts, as a conservative approach. No matter how the overall execution ends up, you would at least know what the LLPA will be up front.

Given the lack of information available now, it makes sense to reduce N/O/O and second home pipeline concentration until we know more about how this requirement will be monitored and controlled by the agencies. Until we have more direction, we recommend that any locks in the open pipeline for loans secured by N/O/O or second homes are sold soon, if possible, and any new locks should have as much extra margin/LLPA built in as your risk tolerance allows.  Keep a close eye on these loans until the path becomes clearer, and as always, keep in close communication with your hedge advisor.