Add-on fees draw fire in mortgage industry and cost thousands

With mortgage rates at unprecedented lows, why are more people not taking advantage of them to refinance or buy houses?

The answers are complex and include sagging consumer confidence in the economy, high unemployment rates and inability to sell their current home so they are not able to move.  But some mortgage lenders point to what they see as overreactions within their own industry that are discouraging and disqualifying potential borrowers — sharply increased credit-score requirements, higher down payments, and add-on fees imposed by mortgage giants Fannie Mae and Freddie Mac, which control about two-thirds of marketplace loan volume.  Thought you were going to get the really low advertised rate you saw.  Chances are slim because of these add-on fees.

Most of these controversial Fannie / Freddie fees, which were introduced as the housing bubble began deflating, are known in the industry as “loan-level pricing adjustments” or “add-ons”.

Many mortgage executives and loan officers think they are excessive or unnecessary, given the stricter underwriting standards now in place that reduce the long-term risk of new loans being originated today.  In the past Fannie and Freddie imposed these fees as they saw their portfolios deteriorating because of defaults on poorly underwritten loans that had loose requirements.  Today those requirements are much tighter and the default rate on newly originated loans is much lower.

Both Fannie and Freddie, which have operated under federal conservatorship since September 2008, maintain sliding scales of fees, starting with a standard one quarter percent “adverse market delivery charge” are needed to help protect them from future losses.  Does charging a ¼% really reduce the risk in a declining market?  Maybe not charging a fee and just asking for a larger down payment would be a better way to minimize risk?

For a $300,000 loan, that’s $750 just to get in the door. On top of that fees calibrated to a sliding scale of down-payment amounts, credit scores and housing types.   They all start to add up to some big dollars.
Say, for example, you want to buy or refinance a condominium. Under Fannie’s latest add-on model, a condo unit buyer who has less than a 25 percent down payment gets hit with three-quarters of 1 percent add-on fee for starters. On a $300,000 condo loan, this comes to $2,250, which must either be paid in cash or rolled into a higher mortgage rate.
The same model imposes additional fees based on applicants’ credit scores. For instance, anyone with a FICO credit score of 679 who is buying a house with 20 percent down — substantial money for most budgets — is assessed a 2.5 percent “loan-level price adjustment” fee.

So adding this up we get the following adjustments:

• Condo < 4 stories:                       .25
• Loan Amount:                           <.50>  — negative are a good adjustment for a borrower
• Condo Loan amount > 75%    .75
• Credit Score 679                       2.50
• Total Adjustments:                  3.0

So that amount on a $300,000 loan means either $9,000 additional closing cost or a rate of 5.375% versus a rate of 4.25% without all the add-on.

If you take the higher interest rate option then your payment is $204.19 higher each month and you end up paying $73,473.86 more in interest if you kept the loan for 30 years.

See an actual Wholesale Rate Sheet If this doesn’t work, you can always just search for those words.

Private mortgage insurance companies, which provide coverage against loss to Fannie and Freddie on loans with down payments below 20 percent, are especially critical of the continuing add-on fees.

They say the extra charges on top of their own insurance premiums routinely discourage borrowers from taking out conventional loans and push them instead to the Federal Housing Administration, whose market share has exploded from under 3 percent to more than 30 percent in recent years.  This is just common sense.  The borrower is going to go to wherever the cost is less.

Even with the FHA’s move to raise its monthly insurance premiums to borrowers recently, private insurers say that in many cases, Fannie’s and Freddie’s add-on fees still make them noncompetitive.
Without the extra charges, they argue, consumers seeking low down-payment conventional loans could be getting lower rates and fees — now — but there’s no sign they will.

Bottom line for borrowers: Absent a sudden change in policy, don’t look for the Fannie-Freddie fees to be cut or eliminated. Both corporations have bigger fish to fry like getting their houses in order from bad prior decisions.