Interest rates began a meteoric rise 18 months ago from lows in the 2% range for a 30-year fixed mortgage to highs of nearly 8%. While this rise eviscerated the refinance market for originators, it has provided homebuyers the possibility of assumption, the most useful and valuable opportunity for relief from today’s housing affordability crisis.
The unfortunate corollary to this sudden opportunity is that it caught servicers completely unprepared for the surge in assumption requests that have continued unabated. Certain government-backed mortgages are all fully assumable as these mortgages do not have a due-on-sale clause, meaning that the original loan does not need to be paid off entirely for a home to be sold.
“About 12 million of these loans, 23% of all active mortgages, are assumable with a market cap in the trillions of dollars.”
About 12 million of these loans, 23% of all active mortgages, are assumable with a market cap in the trillions of dollars. Many of these homes have interest rates at 3.5% or lower that buyers can take over with a successful assumption. For these transactions to take place, the current servicer must process the assumption of the existing seller’s loan by underwriting and qualifying the prospective buyer.
This should be a simple task, given the loan is already funded, insured and sitting in both a Ginnie Mae pool and the servicer’s existing servicing platform. This should take little time — most lenders have excess underwriting capacity at the moment — but that doesn’t appear to be the case.
Just 6,400 assumptions were completed in 2023 and complaints filed with the Consumer Financial Protection Bureau (CFPB) against servicers regarding delays in assumptions have risen from 67 in 2021 to 149 in 2023. Apparently, mortgage servicers haven’t quite figured out how to handle these in a timely and orderly manner.
Revenue loss
Mortgage companies make much less money on handling assumptions than they would processing a new purchase loan and that might be one of the reasons for the relatively small number of assumptions and the rise in complaints. The Federal Housing Administration (FHA) currently allows the servicer to charge $900 to process the assumption. A recent FHA mortgage letter will double the fee on FHA assumptions to $1,800 starting this month.
The U.S. Department of Veterans Affairs (VA) charges a flat fee by region, but that ranges from $463 in the West to $386 in the Midwest. While these sums are small and certainly not the profit centers servicers and lenders wished they were, they are not reflective of what a servicer actually loses when a loan is paid off rather than assumed.
Servicers typically make between 25 to 35 basis points a year to service a particular loan. So, for example, a mortgage company that services a $500,000 loan could earn about $1,500 a year (about 30 basis points) in servicing fees to collect payments, provide customer service, process modifications/foreclosures and ensure insurances and taxes are paid.
In addition, they have to place on their balance sheet the value of the cash flow the future mortgage servicing rights (MSR’s) provide, which typically range between 150 and 200 basis points. So, when the $500,000 loan is paid off rather than assumed, the servicer loses a borrower, the processing fee, the annual recurring revenue of servicing fees and their balance sheet gets a buzzcut. This should give indigestion to chief financial officers of mortgage companies, given the current state of the mortgage industry’s financial condition.
But there are opportunities for mortgage companies. Assumptions provide the chance to those servicers who originate mortgages to provide second trust deed financing to address the financing gap between the assumed loan balance and the sale price, where the buyer doesn’t have the funds themselves to accomplish this. Assumptions also allow servicers to connect with their existing borrowers/sellers and offer mortgage products to them for the likely subsequent purchase they will be making.
Potential sanctions
In response to increases in complaints against servicers for non-compliance with assumption rules and timelines, the VA issued a strongly worded notice in December. Titled “Noncompliance in Processing Assumptions” — or VA Circular 26-23-27 — the notice emphasizes that a servicer has 45 days to approve an assumption.
In addition, it bans investor or servicer “overlays” (lender-imposed criteria stricter than VA requirements), such as FICO score minimums and second trust deed restrictions. The penalty for non-compliance is severe. On any particular loan, if the VA determines that the servicer is not complying with their time requirements, the VA can reduce the loan guaranty to zero. For repeated non-compliance, the discipline ranges from referral to the VA’s Office of Inspector General for investigation, to the VA banning such a servicer from servicing or acquiring guaranteed loans.
While FHA guidelines also require the servicer to complete an assumption in 45 days, the U.S. Department of Housing and Urban Development (HUD) had yet in early summer to follow the VA lead and set forth penalties for failure to comply with this timeframe. Expect that to occur. HUD has a significant dog in this fight. HUD collects a mortgage insurance premium on each of its mortgages until the loan is paid off. An assumed mortgage would continue those payments. Also, housing affordability has never been more challenging and one way to offset that is to allow for more assumptions, virtually guaranteeing HUD scrutiny of servicers moving forward.
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Assumptions are good for homebuyers, sellers and even mortgage companies. If servicers are not proactive in making the assumption process timelier and more efficient, real estate agents representing the buyers and sellers will be reluctant to put together a deal that includes assumption over their understandable fear that the transaction will take too long. And it will be difficult to unring that bell.
