Will Rising Unemployment Cause Another Mortgage Meltdown?

This week 4.4 million more Americans filed for unemployment benefits. That brings the Shelter-in-Place 5-week total to 27 million Americans out of work, 16% of the workforce. It erases all the U.S. employment gains since the last great recession of 2009. Although this economic downturn is a result of COVID-19 and not a “mortgage meltdown,” how will all of these out-of-work borrowers affect the mortgage market?

As more Americans become impacted due to job loss and furloughs, it will make it difficult, and sometimes impossible for homeowners to make their mortgage payments. The U.S. government has stepped in to offer homeowners financial relief during this unprecedented time with the Coronavirus Aid, Relief, and Economic Security (CARES) Act. With this new Act, government-sponsored agencies, such as Fannie Mae and Freddie Mac, will offer forbearance agreements with protections for those homeowners in need.

But forbearance means suspending mortgage payments for a certain amount of time. How will that affect the mortgage market? How can a mortgage lender sell a newly funded mortgage into a mortgage-backed security (MBS) if it’s possible the very first scheduled payment is not made on time by the borrower, let alone the next few payments, during this crisis?

Fannie Mae and Freddie Mac say they will temporarily buy and securitize loans in forbearance, meaning lenders can sell or securitize their new loans, even if the first few monthly payments are late. Know that no lender, including depository banks, wants to be sitting on unsold or unsaleable loans that are in forbearance. So there are going to be strict requirements and pricing will be adjusted to accommodate the risk. For example, first-time homebuyer loans could expect a government-sponsored enterprise (GSE) pricing hit of 500 basis points (5%). All other loans could expect a 700 basis point pricing hit (7%). And forget about cash-out refinance loans. It does not look like they will be included in this Fannie/Freddie forbearance securitization plan. We shall see how that all plays out.

The good news is there are still purchase loans, refinance loans, and even cash-out refinance loans being originated. Just expect pricing on new loans to be affected and qualifying criteria to be tightened up.

Meanwhile, institutional investors are not buying MBS. The Fed stimulus intervention of buying an unlimited supply of MBS has propped up the mortgage market. But the Fed started decreasing the amount of buying per day. The Fed’s intent is not to push rates lower. Rather, they want to stabilize and add liquidity into the MBS market. And they are succeeding.

So, if you are looking to buy or refinance your home, you probably should not hold out for rates to drop lower. Here is why:

1. The Fed continues to buy fewer MBS. Without Fed buying, there is downward pressure in MBS prices and, inversely, upward pressure on rates.
2. Capacity and risk aversion are keeping lenders from lowering rates.
3. MBS carry a new risk of default due to an elevated 16% unemployment rate.
4. The good news that pockets of the economy will start to re-open is potentially inflationary and bad for interest rates.
5. The craziness in the oil market seems to have settled. Again, MBS hates good economic news.

The bottom line: If you can lock your rate, you should lock your rate.