Freddie Mac’s proposed home equity product could unlock $850B in originations

A Freddie Mac home equity product that was proposed this week has the potential to unlock $850 billion in origination volume. But it could face challenges due to the lack of a robust securitization market, according to strategists at Bank of America (BofA). 

On Tuesday, the Federal Housing Finance Agency (FHFA) announced a request for comment on a proposal to allow the government-sponsored enterprise (GSE) to purchase single-family, closed-end second mortgages when it owns the risk of the corresponding first-lien mortgage, subject to a combined loan-to-value ratio lower than 80%. 

If the home equity product is approved as proposed, it will have terms of up to 20 years, be manually underwritten and remain in Freddie’s portfolio for six to nine months until the creation of second mortgage non-TBA-guaranteed securities. Meanwhile, borrowers will be unable to refinance their first mortgage until the product is paid off, unless prohibited by law.

The new product is an alternative to a traditional cash-out refinance, which requires refinancing the outstanding loan balance at current interest rates. This week, the 30-year fixed mortgage rate topped 7% for the first time this year, according to Freddie Mac. Consider that 63% of outstanding mortgages have a sub-4% mortgage rate, per estimates by the BofA strategists. 

Second mortgages are also typically offered at a lower interest rate than certain alternative products like personal loans. 

“The proposed activity is intended to provide homeowners with a cost-effective alternative for accessing the equity in their homes,” FHFA Director Sandra Thompson said in an announcement of the proposal.

In a report published on Wednesday, the BofA strategists calculated that if Fannie Mae launched a similar product, it could do $1 trillion in closed-end, second-lien mortgages. Thus, “for mortgages owned by the two GSEs, equity extractions could be as much as $1.8 trillion on sub-4% loans, keeping the CLTV below 75%,” the group added. 

To compare, second mortgages and home equity lines of credit (HELOCs) have a current outstanding balance of $512 billion, with $150 billion estimated to be closed-end, second-lien loans, per the BofA report. 

The secondary market, however, can be a challenge for these products.

In 2023, the securitization volume for HELOCs and closed-end second liens reached $4.5 trillion. This year, the volume to date is $2.6 trillion, with an expectation of another $8.4 trillion by the end of December, according to BofA. 

“Financing options are particularly important given the increasing share of second liens originated by non-depositories,” the strategists wrote in the report. “We think that the new product could, in turn, enhance originations by providing one more financing outlet, and we expect that it could quickly exceed credit union and RMBS-securitization bids.” 

The comment period lasts 30 days from the proposal’s publication in the Federal Register and ends on May 16, 2024.