The Federal Reserve has seen the economic impact of a housing crisis before. Last March, as the impact of COVID-19 on the labor market was just coming into focus, it took steps to support the markets and calm fears of a wave of imminent foreclosures like what we saw in 2008.
To support a continuing flow of credit and liquidity, the Federal Reserve again began purchasing sizable amounts of agency mortgage-backed securities (MBS), among other measures taken in support of the economy like lowering short-term interest rates. The last time it bought significant levels of MBS was after the 2008 housing crisis. That round wound down in October 2014.
The Fed has a huge impact on all kinds of interest rates, including mortgage rates, through its control of short-term interest rates. Today, we’ll take a look at the Fed's work in the MBS market.
Let’s take a look at what a mortgage-backed security is, how the Fed is helping mortgage rates by purchasing them and what happens when they stop. In this way, you’ll know what’s affecting the market when you’re ready to apply for a mortgage.
What Is A Mortgage-Backed Security?
A mortgage-backed security (MBS) is a pool of home loans, often packaged by Fannie Mae, Freddie Mac or Ginnie Mae, sold on the open bond market to investors. The investors who buy the securities then receive the payback on a monthly basis when homeowners make their principal and interest payments.
The investors also have certainty in their investments. The majority of mortgages are backed by the U.S. government, either directly or indirectly. FHA Loans and VA Loans have direct government guarantees and are sold into the bond market by Ginnie Mae; Fannie Mae and Freddie Mac are government-sponsored entities (GSEs).
Each of these mortgage backers has specific requirements for the loans they sponsor. In exchange for the lender making sure the client is properly vetted and meets the appropriate qualifications upfront, they buy the loan from the lender, which is combined with other loans to make a mortgage-backed security sold to bond market investors.
These agencies agree to take the responsibility to recover as much as they can for investors or the lender if something happens and the client ends up going into default. One of the ways they try to do this is by requiring that lenders or mortgage servicers continue forwarding the principal and interest payments that would have been due on those mortgages by drawing on their reserves for a certain number of months.
If the property were eventually taken over by the lender, the hope would be that the proceeds of any sale would cover losses, but these can be difficult to fully recover. In this way, there's no specific guarantee of returns. Instead, you're getting a promise when you buy into a certain MBS that it's been underwritten to standards defined by their lending requirements.
How is it decided which mortgage loans go into any given MBS? Let’s take a brief look.
Let’s say John Doe just closed on his conventional loan. He has a 640 credit score, paid a 3% down payment and has a 30-year term. Freddie Mac insures his loan because it meets their guidelines.
Once the loan is insured, it’s put into an MBS with other loans that have similar characteristics, such as credit score, down payment size, term length or loan-to-value (LTV) ratio, which is a client’s down payment or equity amount.
After all the loans are in the MBS, it’s ready to go out on the open bond market. Mutual fund managers, 401(k) custodians and even individuals can buy an MBS based on the characteristics of a particular pool. If the entity managing your retirement funds happened to buy into the right pool, you could even own a piece of your own mortgage without knowing it.
Now that you know how the MBS market works, let's take a look at the specific type of MBS being bought by the Fed.
What Is An Agency MBS?
The Federal Reserve is currently buying $40 billion worth of agency MBS every month in order to support the housing market. When they refer to agency MBS, they mean specifically purchasing those mortgage-backed securities which are made up of mortgages from Fannie Mae, Freddie Mac and Ginnie Mae.
It’s important to note that outside of what the Federal Reserve says, agency is sometimes used in the mortgage space to only refer to the conventional loans backed by Fannie Mae or Freddie Mac. If you’re looking at investing in MBS, make sure you know what you’re getting.
Agency MBS Vs. Non-Agency MBS
Because agency MBS has two different meanings, defining a non-agency MBS can be the same way. As mentioned above, when speaking about the mortgage itself, non-agency MBS could simply refer to anything that’s not a conventional loan. In the context in which the Fed is using it, it would mean anything that’s not a conventional loan or otherwise backed by the government.
Some examples of non-agency MBS would be things like jumbo loans or interest-only mortgages that are done by some lenders. These have different guidelines from anything Fannie Mae, Freddie Mac or the government would back. The Federal Reserve has been buying agency MBS because these are held to strict standards and can be considered less risky.
What Is An Agency MBS Purchase?
The last time the Federal Reserve undertook a program of agency MBS purchases, it was helping shore up Fannie Mae and Freddie Mac, which along with Ginnie Mae are key in keeping housing markets liquid, meaning people can find financing to buy and sell homes.
One of the big aims at the time was to provide some mark from the agencies to offload bad investments in what was called the Troubled Asset Relief Program (TARP). At the time, many lenders and mortgage investors were making and buying up subprime mortgage loans, loans that were made at higher rates, to borrowers with questionable credit histories.
The pain began when these borrowers started defaulting on their mortgages in 2008 as home prices begin to drop precipitously. The Fed considered the move necessary in order to protect the functioning of the market.
After TARP, the Fed had several other rounds of investment in agency MBS, but they wound the program down in October 2014, choosing to only invest the profits from previous purchases into new agency MBS.
In March 2020, in response to market turmoil caused by COVID-19, the Fed chose to restart major purchases of MBS in order to keep rates low and maintain housing affordability during a difficult period. As of this writing, since the Fed began taking on additional MBS in March, the initiative has added $697,943,000,000 to its balance sheet. That’s a lot of digits – nearly $700 billion. That’s a huge outlay, and shows just how serious the Fed is about this.
The Federal Reserve And MBS
The Federal Reserve has a vested interest in the housing industry succeeding in this country. Housing makes up a huge portion of this country’s gross domestic product (GDP). GDP places a real dollar value on all finished goods and services produced in the U.S., taking into account consumer spending, the value of inventories, government spending and exports while subtracting imports. GDP may be the single most important measurement when we look at how fast the economy is growing.
According to an October 2019 report by the Congressional Research Service, spending on residential investment between single and multifamily homes accounted for about 3.3% of overall economic activity in the U.S. in 2018. This includes cost for construction, remodeling and agent or broker fees.
The same report showed that spending on housing services including things like rent, what the equivalent rent would be for owners who were renting the same space and utility payments made up about 11.6% of overall U.S. GDP. Taken together, housing represents almost 15% of total economic output.
Housing is a huge economic driver, so it makes sense for the Fed to encourage homeownership and construction.
One of the ways it helped accomplish this was to move short-term interest rates down to near 0% for quite a while so that lenders could pass that savings on to their clients. Still, that only drove mortgage rates down so far. In order to drive borrowing costs even lower, the Federal Reserve has in recent years taken the unusual step of entering the market for mortgage bonds.
In order to further stimulate economic growth and drive interest rates down even lower, the Federal Reserve uses a policy of quantitative easing. Although it has a fancy name, it basically just means that the Fed choses to enter the bond market to buy various securities and other assets to keep credit flowing at low interest rates.
When a new buyer enters the bond market and buys a lot of any particular bond, the yield or rate of return for that particular bond may be driven to low amounts because the return doesn’t have to be high in order to attract investors – there’s already a motivated buyer out there.
The biggest beneficiaries of the buying brought on by quantitative easing are agency MBS and, by extension, mortgage rates.
As of this writing, the Federal Reserve is holding $2,069,789,000,000 worth of agency MBS. This is helping to hold mortgage rates down. In addition to the funds being spent on new MBS mentioned earlier, each time a security matures, the Fed is reinvesting those principal and interest payments in MBS, which is also helping grow its mortgage bond holdings.
Mortgage Rate Effects
In order to truly understand the effects of the Federal Reserve re-entering the bond market, it’s important to understand just how big of a player the Fed is.
Among the bonds being purchased in huge quantities are the fixed-rate MBS offered by Fannie Mae, Freddie Mac, FHA and VA. The Fed’s actions keep the demand for agency MBS up and mortgage rates stable.
What’s the bottom line if you’re looking for a mortgage? This level of Federal Reserve intervention is helping to keep mortgage rates lower than they otherwise would be. Rates are really near historical lows, so if you're ready, it's a real opportunity.
When Will The Foreclosure Wave Hit?
With prices at high levels, it can be tempting to conclude that we’re in the middle of another housing bubble. However, in addition to the Fed keeping interest rates low, there are a couple of factors that make what happened in 2008 unlikely to happen again this time around
Stricter Mortgage Underwriting
Since the last housing crisis, stricter laws and regulations were put in place to prevent the kind of lax approvals that led to the last crash. To begin with, whether conforming loans backed by Fannie Mae and Freddie Mac or nonconforming loans backed by the government or other entities, lenders evaluate based on factors like credit, assets, and debt-to-income ratio (DTI).
Lenders also are subject to much more government regulation than before the crisis. The Consumer Financial Protection Bureau plays an active role and mortgage investors have tightened their standards.
Consumer Protection Laws
Known as the “Know Before You Owe” regulations, in October 2015, the federal government mandated the simplifying of forms under both the Truth in Lending Act and the Real Estate Settlement Procedures Act. The upshot of the simplifications was the creation of a new loan estimate at the beginning of the process and a closing disclosure.
The Loan Estimate is given no later than 3 business days after a potential home buyer or refinancing homeowner has officially completed an application. The Closing Disclosure is given at least 3 business days before closing.
These documents provide the high-level details of everything you need to know about your loan including the interest rate, whether that rate is fixed or adjustable, whether there’s a balloon payment or any prepayment penalty that applies. These documents also break down the costs associated with your loan.
Finally, there are rules regarding which numbers can change and how much between your loan estimate and closing disclosure, so these things are really all geared around consumer protection.
A forbearance of your mortgage is a temporary pause of your mortgage payment. There are many different types of forbearance that depend on your situation. If you apply for a forbearance, it must be approved by lender or mortgage servicer. Although you have to make up missed payments, it does give you the opportunity to get your feet under you.
Because of COVID-19, Congress authorized the ability for people to request 6 months’ worth of forbearance within the CARES Act, with the ability to request a 6-month extension for those impacted by the virus.
Although your options for exiting forbearance will vary depending on your situation and what you qualify for, here are some common options:
- Repayment plan: An amount is added to your monthly payment over a period of time until you’ve caught up.
- Payment deferral: Depending on the investor in your mortgage, you may be able to have up to a year with the payments deferred until you sell the house, refinance or the loan is otherwise paid off. No extra interest is added.
- Loan modification: You may qualify for a loan modification where the interest rate and/or the term of your loan could be changed with the goal of making your payment more affordable.
You do always have the option of making the full past-due payment when you exit forbearance, but we understand that this isn’t feasible for many people. If you’re a Rocket Mortgage® client in need of assistance, you can fill out our Application for Success.
There are eviction and foreclosure moratoriums in place for properties backed by government loans. Additionally, the Federal Housing Finance Agency recently announced that the moratoriums would be extended for Fannie Mae and Freddie Mac through March 31, 2021.
This is meant to give people more time to consider their options and avoid waves of foreclosures due to COVID-19.
In Times Of Uncertainty, The Fed Acts To Protect The Housing Market
The Federal Reserve saw the effects of the 2008 housing crash. Since then, it’s taken steps to prevent such turmoil through its own market intervention, including the purchase of agency MBS.
Agency MBS are mortgage bonds which have underlying mortgages backed by Fannie Mae, Freddie Mac and Ginnie Mae. The purchase of these MBS by the Fed helps keep rates low and maintains a steady flow of credit. This intervention is key because homeownership accounts for around 15% of total U.S. GDP.
Together with the actions of the Fed, factors like stricter mortgage underwriting, new consumer protection laws, mortgage forbearance options and foreclosure moratoriums at appropriate times all work to protect the consumer and avoid a repeat of 2008.
Now that you understand the impact of the Fed’s bond buying and its impact on the housing and mortgage markets, you can apply online if you’re ready. You can also speak with one of our Home Loan Experts at (833) 230-4553.