The drive to reform the GSEs is raising two questions that could fundamentally reshape the way borrowers obtain mortgages: will a revamp effectively eliminate the 30-year fixed rate mortgage, and would that be a good thing?
For decades, it's been conventional wisdom that the 30-year fixed rate mortgage is the best option for most homeowners, and any attempt to restrain or supplant it has largely failed to take hold. But efforts to replace Fannie Mae and Freddie Mac are likely to — at the very least — make such mortgages more expensive. Depending on what approach Congress and the Obama administration take, the ultimate plan could eliminate such types of loans entirely.
While that prospect likely still disturbs many banks and lawmakers, some in the industry say it is time to reevaluate the benefits of the 30-year fixed mortgage.
"There is a lot of skepticism about whether it is quite the gold standard as some hold it up to be," said Bert Ely, an independent consultant based in Alexandria, Va. "Fannie and Freddie did a very effective job of convincing Americans that a 30-year fixed rate mortgages was the thing to get. But one of the things that is happening very slowly is some rethinking whether a 30-year fixed rate mortgage is the best thing to get."
The 30-year fixed-rate mortgage has evolved into the traditional home loan in the United States, although it has proven far less popular in other countries. Its advent mostly owes to implicit or explicit government backing, because banks generally are unwilling to hold such long-term maturities which are funded by short-term deposits.
But fixed-rate mortgages with such long terms require some kind of securitization vehicle to buy them. If Fannie and Freddie are eliminated and the government's role reduced, it's not clear if any fully private market player would be willing to take up that mantle.
The Treasury Department has proposed three options for reforming the housing-finance sector. In all three, the government would provide significantly less support. Depending on how far Congress is willing to privatize the system, the costs of the 30-year mortgage are at least expected to rise, becoming potentially prohibitive under certain scenarios.
As a result, some observers said other options, such as adjustable rate mortgages - may become more attractive to borrowers.
"The discussion is shifting in that direction," said Glen Corso, managing director of the Community Mortgage Banking Project. "Proponents of a purely private mortgage market can't answer the question about whether investors will be there and are willing to invest money for 30 years without a government guarantee. Because of that uncertainty advocates of a purely private market are now trying to shift the terms of the discussion to, 'Maybe we don't really need a 30-year fixed rate mortgages? Maybe we can get by with a 5-, 7-, or 10-year fixed rate mortgage?'"
The question of whether the 30-year fixed mortgage is really necessary underscores the entire GSE debate, observers said.
"That's the threshold question before you get to reform," said Jaret Seiberg, an analyst for MF Global's Washington Research Group. "Because if your answer is yes, it's hard to envision a market without any sort of government presence, but if the answer is no, you probably can dramatically dial back the government's role."
Of the three options the administration laid out in its white paper in February, its first option would likely eliminate the 30-year fixed mortgage altogether. Under option one, the government would significantly scale back support, leaving only the Federal Housing Administration (FHA) and a few other targeted programs to help low-income borrowers.
Option two would call for some kind of government guarantee of the mortgage market that could be scaled up in bad economic times and reduced during boom times. Because the concept of a guarantee is so vague, however, it's unclear what kind of impact it would have on the 30-year fixed-rate mortgage. In theory, it could be structured to preserve it or eliminate it.
Under the third option, the long-term fixed-rate mortgage is likely to survive, although it would probably cost more for borrowers. Option three would allow a group of private mortgage companies to provide guarantees for mortgage-backed securities that meet certain strict underwriting criteria. A government entity would then provide reinsurance to the holders of the securities, which would only be paid if shareholders were entirely wiped out. The government would charge a premium for its reinsurance that would be used to offset losses to taxpayers.
The key test then becomes how expensive each of these options would make a long-term mortgage in comparison to shorter-term loans.
"From a borrower's standpoint, generally the behavior I have seen in the past is a tug and pull between having a fixed payment that lasts for a long time that provides certainty - and all things being equal that's what a borrower tends to prefer," said William Longbrake, an executive-in-residence at the University of Maryland and former vice chairman at Washington Mutual. "But the other piece of that is monthly payments matter, and usually on a 5-year the monthly payment is a little less than on the 30-year."
To be sure, some argue a fully privatized market may allow for a 30-year mortgage, contending that interest rates may go up, but housing prices may go down.
"People say well, wouldn't the interest rate be probably somewhat higher?" said Alex Pollock, a fellow for the conservative think tank American Enterprise Institute. "I think that's right. It probably would be. But I think house prices would be somewhat lower."
But without GSEs to buy long-term fixed-rate loans, it is unclear who will take up the slack. Pete Mills, a principal at Mortgage Banking Initiatives, said the key potential buyers would be pension funds, insurance companies or hedge funds that are comfortable with long-term exposure.
He noted, however, that their interest may be affected by the forthcoming risk retention rule, due out Tuesday, which requires lenders to keep an interest in loans they sell to the secondary market unless they meet certain criteria, dubbed "qualifying residential mortgages" (QRM) that make them exempt.
"To have a 30-year fixed rate without FHA, you have to have a securitization vehicle," Mills said. "If QRM is drawn so narrowly that only a handful of loans qualify at 20 percent, or 25 percent, or 30 percent down payments, then you won't see a whole lot of fixed rate product out there."
Even if the 30-year fixed-rate mortgage continues to exist, it may look radically different.
"The real question in many ways is not so much whether a 30-year fixed-rate mortgage will exist, it's will people want a 30-year fixed mortgage rate which might exist absent Fannie and Freddie and FHA?" said Ely. "It's really more a matter of price, the interest rate, not the product itself."