Why are mortgage fees so much higher for mom-and-pop investors?

A Fed study suggests there is almost no risk financing rentals for investors, so why are Fannie and Freddie charging so much?

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | August 21, 2023

Article originally posted in Orange County Register on August 17, 2023.

Freddie Mac rates climbed past the 7% mark, landing at 7.09% on Thursday, Aug. 17. Bad as that is for borrowers, it’s looking much worse for those who seek financing for an investment property.

In January, the Federal Reserve Bank of Philadelphia published a study on owner-occupancy fraud and mortgage performance.

The study of mortgages from 2005 through 2017 by Fannie and Freddie, bank portfolios and private securitized mortgages found that one-third of investors were committing occupancy fraud — that is, borrowers were misrepresenting their occupancy status as owner-occupants rather than investors.

But deep in the data of the study, I confirmed a hunch I’ve long had about mortgages and property investors. Risk, by and large, is low for properties that are mortgaged by legitimate investors.

And yet, despite that risk, Fan and Fred charge exorbitant fees for mom-and-pop investors.

Here’s how it works …

Mortgage originators package loan applications and related documents. Mortgage lenders underwrite and fund the loans. Fannie and Freddie may opt to buy the closed loans from the lenders.

In those cases, Fan and Fred provide pricing to the lenders. They use a very sexy name for this, though I think it’s certainly disingenuous, calling it risk-based pricing.

For example, I priced out a $750,000 single-family property, assuming 20% down for a loan amount of $600,000 and a 740 middle FICO score.

The 7.5%, 30-year fixed, owner-occupied mortgage cost the borrower $966 in loan origination points. Compare that to the identical 7.5% rate costing $21,966 for the investment property purchase. Fannie charged $21,000 more for the rental (Fan and Fred usually offer nearly identical pricing).

Can you say highway robbery?

 Fannie’s mission is to facilitate equitable and sustainable access to homeownership and quality, affordable rental housing across America.

Freddie’s mission is to lead the U.S. housing market forward, making homeownership and rental housing more accessible and affordable nationwide. Besides fleecing small landlords, how does this help rental properties to be equally or more affordable for the tenants?

The old wives’ tale, passed down from generations of mortgage loan originators to borrowers has been that rentals are riskier bets for the likes of Fan and Fred. The big ideas are tenants don’t provide the same level of TLC as owner-occupants do. So, if the lender forecloses, it’s going to take a lot of money to get it into selling shape.

And if you get into financial trouble, you’re going to walk away from your rental house before mailing your keys back to the lender. Therefore, Fan and Fred need to charge more.

What about competitors, you ask? Other sources for investor mortgages are the so-called exotic mortgage lenders, aka non-qualified mortgage lenders. They do the likes of using alternative income like bank statements (Fan and Fred require W-2s, paystubs, and tax returns for example).

These non-QM mortgages can carry substantially higher rates than Fannie/Freddie investor rates. Depending on loan size, loan to value and FICO scores, the rates can be 2 points higher than the Fan/Fred non-owner rates.

Back to the enlightening Philly Fed working paper, which included a broad-based group of borrowers including mortgages sold to Fannie and Freddie and other institutions. The study says at least a third of investment borrowers misrepresent their occupancy status as owner-occupants rather than investors in residential mortgage originations.

Occupancy fraud allows riskier borrowers to obtain credit at lower interest rates.

These fraudulent borrowers perform substantially worse than similarly declared investors, defaulting at a 75% higher rate, according to the study.

Regardless of any occupancy fraud, the data shows investors defaulting (60 or more days late) within two years of loan origination was nearly zero. Some of the time periods studied, however, were in the largely lawless Wild West mortgage days of 2005-2007 when defaults ran at 11%. The other period was 2008-2017 with .04% defaulting.

For good measure, I wanted to better understand if there was such fraud risk justification to charge investors more.

Neither Fan nor Fred responded to my mortgage fraud queries. Neither did the California Attorney General’s Office.

The FBI did respond, saying “recent indicators and financial industry reporting does not suggest occupancy fraud is either prominent or widespread.”

A bureau representative said occupancy fraud as a possible fraud scheme represented around 2% of suspected mortgage fraud instances in 2023. The agency noted it was 2.3% in 2022.

“More generally, the FBI has not seen any notable changes in reporting of mortgage fraud in recent years, remaining relatively flat over the last four years.”

Veterans Affairs or VA does not offer the investor loan option.

HUD gets the gold star for diligence, especially since FHA has limited exceptions allowing investors to have FHA mortgages.

HUD has a variety of exclusionary lists and internal controls to prevent ineligible parties from participating in FHA programs. In the past three years (August 2020-August 2023), HUD has referred approximately 320 cases of suspected occupancy fraud to the HUD Office of Inspector General, according to a HUD spokesperson.

If you want to buy an investment property, first figure out if you can pull enough cash out from your residence, for example. Maybe you can pay cash for the rental. Pricing will be a lot cheaper.

Freddie Mac rate news: The 30-year fixed rate averaged 6.96%, six basis points higher than last week. The 15-year fixed rate averaged 6.34%, nine basis points higher than last week.

The Mortgage Bankers Association reported a 3.1% mortgage application decrease compared to last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $815 less than this week’s payment of $4,812.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 6%, a 15-year conventional at 6.125%, a 30-year conventional at 6.5%, a 15-year conventional high balance at 6.625% ($726,201 to $1,089,300), a 30-year high balance conventional at 7% and a jumbo 30-year fixed at 6.875%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.

Eye catcher loan program of the week: A 30-year FHA fixed rate at 5.5% with 2 points cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.