QUESTION
Our loan committee wants to originate portable mortgages. I am an old school guy! Is this the new gimmick to generate sales? I don't know, but it doesn't make much sense to me. When I was with Chase back in the eighties, there was a rollout similar to a portable mortgage. Well, it crashed and burned! Yet, now it's back.
The whole deal mostly rests on the lock-in effect. You should explain it to your readers. And, contrary to the hype I'm hearing, the portable mortgage can lead to increased risk, and prices can go up. On top of that, there's no secondary market.
Are portable mortgages yet another gimmick to generate sales?
SOLUTIONS
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RESPONSE
I understand your concerns, but I would not assert that private enterprises and government entities are concocting some grand scheme in considering a comeback of portable mortgages. As usual, market histrionics are fluttering about like untethered balloons.
Granted, many features of portable mortgages pose risks for both homeowners and investors.
Your memory of the portable mortgage offered by Chase Home Mortgage in the late eighties is correct. So, the basic structure of the portable mortgage goes back to that time. Chase viewed it as experimental in the sense that it was more of a prototype; that is, it was notionally a portable fixed-rate mortgage.
However, true portability has never been achieved in this country. This is because of the prevalence of "due-on-sale" clauses that require the loan to be paid off when a home is sold. I remember that E-Trade offered a version in the early 2000s as a portable "option." Around that time, my firm provided compliance guidance to E-Trade in its development of mortgage banking compliance, but a compliance review of the portable "option" was not in our remit. The fact is, portable mortgages have remained niche products, at best. And for good reason, which I will explain shortly.
One reason it did not catch on is obvious: the U.S. mortgage industry's structure, in which loans are often sold to investors or entities like Fannie Mae and Freddie Mac, has historically not supported portability.
No portable mortgages are currently allowed by Fannie Mae and Freddie Mac, but the Federal Housing Finance Agency (FHFA) is now actively evaluating whether to implement them in the future. Current news reports that the FHFA is working with Fannie Mae and Freddie Mac to determine how to make these loans possible in a safe and sound way, which strikes me as quite a heavy lift. Currently, Fannie and Freddie only allow fixed-rate loan transfers in limited situations, such as due to the death or divorce of the original borrower.
The "hype" you are hearing concerns the GSE approval of portable mortgages, based on the claim that they could make it easier for homeowners to move and keep their lower interest rates, thereby unlocking more homes for sale. Maybe so. Then again, maybe not.
Let's tack down a few important details about the structure of portable mortgages.
A portable mortgage is a home loan that allows a homeowner to transfer their existing interest rate and terms to a new property when they move. In theory, this can save the homeowners money on closing costs and help them avoid taking out a new loan at a potentially higher interest rate. Nevertheless, the new property must meet the lender's criteria, and the homeowner must requalify financially.
PORTABLE MORTGAGE TRANSACTIONS
Here is a brief outline of how the portable mortgage works:
· Transferring the Loan
When selling one home and buying another, the existing mortgage is "transferred" to the new property.
· Requalification
The borrower must still meet the lender's financial criteria and requalify for the loan, just as with underwriting and eligibility requirements for a new mortgage.
· Price Differences
Buying
a cheaper home: The remaining balance on the old loan is reduced by the
proceeds from the sale of the old house. If the borrower is downsizing, the
proceeds from the sale of their old home are used to pay down the mortgage
balance to fit the new property's value.
OR
Buying a more expensive home: The borrower must cover the price difference with cash or a new, separate loan, which would likely be at the current market rate. If the new property costs more than the remaining balance on the borrower's portable mortgage, they would need to cover the difference with either cash or a second loan at the current market rate. This can result in two mortgages with different interest rates and payment schedules.
· Fees
In theory, the borrower could save on some refinancing
costs, but they would still have to pay for appraisals and title recording for
the new property, among other things.
LOCK-IN EFFECT
You mentioned the "lock-in effect." This
happens where homeowners with low rates are hesitant to sell and take out a
new, more expensive mortgage. This is not so easily overcome with a marketing
strategy. Another term for it is "golden handcuffs" because
homeowners are financially tied to their low-rate mortgages.
Combatting the "lock-in effect" is asking the
borrower to make a counterintuitive decision. Homeowners are reluctant to sell
their properties because they have low mortgage interest rates and they would
have to take on a new, much higher-rate mortgage. The fallout to the housing
supply follows because a borrower is discouraged from moving, even for a new
job or a different home, which reduces the supply of homes on the market and
puts upward pressure on prices. Thus, the unwillingness to sell keeps a large number
of homes off the market, constricting the housing supply and making it more
difficult for new buyers to find a home.
I do get that the "lock-in effect" may encourage
mobility. After all, portable mortgages could help alleviate the "lock-in
effect," since homeowners with low rates are reluctant to move because
doing so would mean taking on a much higher mortgage payment. As a theoretical
matter, this could potentially free up housing inventory. The fact is, however,
every metric I've seen shows that the "lock-in effect" has
significantly reduced the number of home sales.
RISKS TO THE BROADER MARKET
Now, let me discuss the impact of portable mortgages on the
broader market.
I will set forth the following description of critical risks relating to portable mortgages, as follows:
The main risks of portable mortgages include higher interest rates for everyone due to investor demand for compensation for added risk, increased complexity for lenders and servicers, and a disruption of the mortgage-backed securities market that helps fund new mortgages. Additionally, only homeowners with low rates would benefit, potentially widening the gap between borrowers, while first-time buyers or those without low rates would not see an advantage.
So what are the risk implications?
The risks to the markets can be extensive and deleterious.
For instance, investors would likely demand higher interest rates to
compensate for the increased risk of holding loans for longer, potentially
pushing rates up for all new borrowers. To compensate for the added risk and
unpredictable loan duration caused by portability, investors would likely
demand higher yields, leading to structurally higher mortgage rates for
everyone over the long term.
There would be a disruption to the mortgage-backed
securities (MBS) market. The current system relies on loan prepayments to
keep mortgage-backed securities functioning. Portable mortgages could break
this model, making it harder for banks to fund new loans and potentially
leading to a less stable market. Mortgages are bundled and sold as MBS to
investors, with the loan's value based on the collateral (the specific
property). If a mortgage is ported, the collateral and its associated risk
change could disrupt the models used to value these securities. Investors
might lose confidence, driving up borrowing costs.
Additionally, the increased market complexity would
force lenders to reckon with new logistical and administrative challenges,
because a mortgage is currently tied to a specific property's collateral,
taxes, and title obligations. The complexity is amplified by reduced
liquidity: if loans are not paid off when homeowners move, there would be
fewer prepayments, which would reduce the amount of cash available for banks to
issue new mortgages.
RISK TO THE BORROWERS
Borrowers face considerable risks. Only homeowners with
low, existing mortgage rates would benefit from portability. This surely does
not help first-time buyers or those who already have higher rates and could
exacerbate the affordability gap between different borrowers. The primary
benefit of portable mortgages would be for existing homeowners with
low-interest rates. Renters, first-time buyers, and those with higher existing
rates would not gain the same advantage.
I can foresee that to get a truly portable mortgage,
lenders will charge a premium or have stricter criteria, meaning some borrowers
may face higher costs for the option itself. If downsizing and porting a
smaller loan amount, borrowers may still have to pay an early repayment
charge on the unused portion of the original mortgage.
Then there's the potential hit to the so-called American
dream of building equity through home ownership. If the portable mortgage
is extended to a longer term (like a 50-year mortgage), borrowers would pay
more interest over the life of the loan and build equity more slowly. Please
see my article on the 50-year mortgage.
And, after all that, eligibility isn't even
guaranteed! A homeowner would still need to qualify for a new loan for any
amount exceeding their portable mortgage balance. If their financial situation
has changed, they might not be able to port the loan to a more expensive home. Lenders
can also change their criteria, potentially leading to a rejection of the
porting application.
Now consider what happens in the transactional mechanics of
selling one home and buying another using the portable mortgage. Lenders often
impose a tight timeframe (for instance, 30 to 120 days) between selling
one property and buying another to port a mortgage. Coordinating closings
within this window can be stressful and complex, legally and logistically.
Finally, there is the lurking issue of "prisoner
risk," which could arise if additional borrowing is required, leaving
the borrower with two separate loans with different terms. This could
"trap" them with the original lender, as refinancing both parts
separately may not be cost-effective.
