Deconstructing the High Cost Mortgage Loan

As many in the manufactured housing industry know, the new Dodd Frank Regulations, specifically the Home Owners Equity Protection Act (HOEPA), which for the first time includes purchase money transactions is very problematic for the manufactured housing industry.  The reasons are more obscure than even those that know and understand finance have considered.

On the surface the regulations declare that any loan carrying an Annual Percentage Rate (APR) higher than the following formulas will be considered a High Cost Mortgage Loan (HCML).

Formula A
Loans under $50,000 with an APR higher than APOR (Average Prime Offer Rate) plus 8.5% will be considered High Cost.

Formula B
Loans over $50,000 with an APR higher than APOR plus 6.5% will be considered High Cost.

Most professionals in the mortgage finance or manufactured housing finance believe the designation of a loan as High Cost is the new term for Predatory. Predatory loans are those loans made by loan sharks and others charging consumers exorbitantly high interest rates in order to generate large profits for taking high risk loans.

The result is that very few loans of what now is termed a HCML are originated.  Lenders do not want to be branded as predatory and furthermore no investor wants to buy HCMLs.

However as it pertains to manufactured housing loans it could not be further from the truth in this interpretation or branding.  Manufactured housing lenders would prefer to charge consumers the lowest possible rate because that would lead to more homes being sold and more financing opportunities.

There are a number of facts that everyone must understand before examining my illustration in deconstructing the HCML interest rate.

Facts:

1. Manufactured housing chattel (home only loan business) does not have a secondary market.  This means that lenders must portfolio their loans.  This subjects each lender to various money costs, various interest rate risk and risk tolerance.   Having a secondary market establishes a firm cost of funds rate. There is no better example than the benchmark used in the formulas above.  The APOR is a Treasury number that is essentially established from Freddie Mac for the best or prime mortgage rates for a given week.  The federal government backs or provides a secondary market for approximately 90% of all mortgage loans originated in the country.  Fannie Mae and Freddie Mac do not offer a secondary market for home only transactions.  FHA Title I and Ginnie Mae do offer a market but have made the cost or price to participate unreasonable and just a fraction of those loans are made.
   
   
2. When considering cost of funds one must consider that depository institutions often have lower costs of funds but also have much lower tolerance for risk.  So the manufactured housing customer who has less than a 650 credit score is generally not going to find a loan with a depository institution.
   
   
3. That leaves private financial terms to borrow money to fund their operations.  Imagine going to the bond market to raise funds for your business of originating manufactured housing loans.  What rates to you think the market would charge?  Certainly higher than those investment opportunities that have little or no risk.
   
   
4. Now that you have borrowed the funds for the loans, consider borrowing funds for generally 5 years and then using those funds for loans that have terms of 15 or 20 years.  The rate you charge the borrower has to include an interest rate hedge.  How much will rates rise over 15 years?  Remember that manufactured housing loans tend not to prepay because of limited refinancing opportunities.  Refinancing occurs when there is a robust secondary market influencing rates. With no secondary market…little or no refinancing.  Lenders then could be holding a loan for the full 15-20 years.
   
   
5. Every lender has to establish loss reserves.  Since those numbers are proprietary consider that on an FHA Title I Loan they charge an upfront mortgage insurance premium of 2.25% and then charge an annual premium of 1%.  And that is only covering 90% of the loss.  The originating lender eats the other 10% plus any additional loss if the home sells for less than the appraised value.
   
   
6. Low balance loans have limitations on points and fees that can be charged.  The Mortgage Bankers Association has testified that their costs of origination run in excess of $5000 per loan.  Keep in mind this includes the cost of compliance which is probably the largest cost item in the equation.  Manufactured housing lenders indicate their costs for a volume operation is in the range of $2500-$3000 per loan.  The points and fees allowed under the HCML threshold do not cover the cost of low balance loan origination.
   
   
7. Servicing costs are not determined by the size of the loan.  There are a myriad of fixed costs that any loan servicer has regardless of loan size.  Consider the average mortgage loan is $222,000.  The GSE’s allow .375% to .50% annually for loan servicing.  Conservatively for a manufactured housing lender to recoup the same servicing dollars represents a substantial increase over the GSE numbers.  Lenders would also argue that their costs are higher because of the need for interpersonal contact with the consumer instead of automated notices.

Therefore when reviewing the Deconstruction of the High Cost Mortgage Loan for Manufactured Housing, consider the facts above and realize that for a lender to make loans there has to be a profit margin.  They cannot make loans at a loss.  

Perhaps our consumer advocacy friends will join us in convincing the GSE’s to make a secondary market for manufactured housing loans so lenders can fix their cost of funds and remove the interest rate hedge so we can make a better cheaper loan market for our manufactured housing consumers.

Loan Assumptions:

• $30,000 loan amount
• 15-year term
• Eight year life of loan
• APOR = 3.25% + 8.5% = 11.75% max APR (APOR as of 10/21/14)
• Sub 640 FICO customer.

Cost of Funds: 5.00%

Interest Rate Hedge: 2.00%
Most MH loans have a much lower repayment or payoff occurrence. Refinances are very limited generally because of the lack of exit strategy.

Reserves for Losses :1.25%  
Using FHA Title I as a government insured loan on a home only transaction calls for 2.25% upfront + 1% annual (assume 8 yrs. on the books) generates $2,750 dedicated for losses (90%) with lender responsible for 10% of loss plus any amount of additional loss if home sold for less than appraised value.   To generate the equivalent dollars would require 1.25% annually dedicated for loss reserves.  

Unrecovered Origination Fees: .50%
Cost of origination and compliance = $2,500 per loan. Assume all five points allowed in points and fees are dedicated to origination cost.  That leaves $1,000 to be recovered over eight years or roughly .50% per year added to the rate.

Servicing Fee: 3.50%
GSE's allow mortgage lenders .375% to .50% annually for loan servicing. Avg. mortgage $222,000 = $845-$1100 per year for servicing.  Cost of servicing a loan is not determined by size of loan. MH lenders incur the same if not higher costs to service because of higher requirement for personal contact and less automated servicing as it relates to delinquent accounts.  On a $30,000 loan 3.5% annual generates the same servicing dollars as the average mortgage.

Total Costs: 12.25%
Before overhead and profit objectives.  This is already over the high cost loan threshold!

Additionally
Manufactured housing borrowers are not paying the following typical costs associated with a mortgage loan, which can add potentially thousands of dollars more either being borrowed and financed or paid out of pocket:

• Application Fees
• Credit Report Fees
• Title Insurance
• Mortgage Insurance
• Closing Agent Fees

Dick Ernst
President Financial Marketing Associates, Inc.