Misguided "High Cost" Rules Limit Access to Affordable Housing Funds
This week USDA announced that lenders could continue to fund loans despite a budget shortfall that had threatened to put an early end to 2010 USDA loans.
As opposed to being the actual “lender,” the USDA “guarantees” loans by charging borrowers an upfront financed fee, similar to FHA. Before the government subsidy dried up, that fee stood at 2%. To continue the funding, USDA was authorized to raise the fee 3.5% which offsets Uncle Sam’s previous contribution.
For borrowers in North Carolina, my home state, this is very bad.
North Carolina already has one of the most restrictive calculations in the country for determining whether a loan is “high cost” (when fees exceed 5% of the loan amount). Now North Carolina has implemented a law that requires lenders to use the USDA Funding Fee in the 5% calculation. The state has the same rule for the FHA upfront mortgage insurance premium and the VA funding fee.
North Carolina is the number one state in the country for the USDA loan program. The USDA loan is intended primarily for low to moderate income borrowers who live in rural communities. Unfortunately the current structure of the high cost rule will effectively prevent good borrowers from utilizing this program for one simple reason: The high cost calculations effectively prevent a mortgage originator from making any sort of income on low balance loans.
For instance, a $75,000 mortgage loan would be restricted to $3750 in fees. Considering that $2625 of that goes to the USDA up front fee, that leaves $1125 for the rest of the prepaid finance charges, which include processing, underwriting, prepaid interest, escrow, and attorney’s fees. In short, not only would there not be enough money to get the loan done, but certainly it would be a zero-profit deal for the originator, thus removing any incentive to allocate resources to the deal in the first place.
These new policies have turned the USDA from being “government subsidized” to being “borrower funded” program.USDA places conditions on their funding commitments it issues. For example, during the borrower funding period, USDA will not insure a loan if there is an early payment default.
Since this provision is in place, most banks will not fund a USDA loan where there is a risk that they’ll be left holding the note on a loan that is ineligible to be in the secondary market. Even before this new legislation, banks have largely utilized the third party origination channel to conduct USDA business due to the larger size of the market. But now that profit on certain USDA loans will be even harder to come by for bankers and brokers are no longer participating in the program. The market for these loans is getting smaller and less competitive. Fewer participants and less competition = higher costs. And if higher costs prohibit the deal in the first place, we’re simply left with a negative feedback loop where the USDA program vanishes completely because no one is offering it.
To be clear, this is not about originators trying to gouge clients. It’s a simple matter of opportunity cost. If originators make zero profit on low balance USDA loans (which most are), what incentive is there for them to even offer the USDA product? If less originators offer the product, less borrowers will have access to these funds!
In the current new loan originations environment, the easy money subprime loan is dead and most of the bad players who focused on it have been forced out of the industry. The diversity of loan products that once fed the housing boom has all but vanished and there are now only a small handful of lending programs that drive the mortgage market. Those left are now using the same 2 or 3 programs--we are all competing for the same business with the same products.
The NC "high cost" law was designed to protect consumers and put an end to predatory lending, and of course, predatory lending is a bad thing, but when we start cutting off noses to spite our face, legislation with a noble intent starts to bring about unintended consequences. Thresholds on fees that immoral originators once used to gouge clients are one thing, but to include government insurance premiums and affordable housing funding fees is a totally different story. These fees are not pocketed by brokers or banks...they are paid directly to the government.
I urge the NC Banking Commission and the NC governing body to reconsider the inclusion of these fees in the high cost calculation. By denying borrowers with lower loan balances the opportunity to get the type of financing that provides them their best rate and payment, we are hurting the very group of people we are trying to protect, not to mention doing damage to the honest originators. It’s truly a “lose-lose” as it stands now. Removing these fees from the high cost calculation is a quick, logical, and simple step toward making it a win-win.