May 6, 2020|GSEs, Mortgage Industry, Virus Response
Nope, TNSTAAFL
One of my college economics professors wrote that crazy acronym on the blackboard the first day of class and returned to it frequently to explain his teaching. I recently heard a large mortgage company CEO tell me the same story about his college econ prof at a different school. It stands for “there’s no such thing as a free lunch” and it is a key Econ 101 lesson. It means that, in reality, a person or a society cannot get “something for nothing”.
Economics and Yeats’ Poetry
The Nobel prize winning economist, Milton Friedman, used to say that economics is simple. “All you have to remember is that demand slopes downward and that nothing’s free. The hard part is applying those two simple ideas.” When Friedman said that nothing was free, he meant that everything has a cost; a cost known as the “opportunity cost”. That’s why the free lunch doesn’t exist. Either the drinks cost more to pay for the lunch or you could be spending your time on something else. Your next best option is your opportunity cost.
Likewise, libertarian economist and social theorist Thomas Sowell[1] explained, “you have to know what you’re giving up in order to get something else. That’s all opportunity cost is, knowing what you are giving up.” Rarely, however, do people properly consider what they are giving up. The great Irish poet, William Butler Yeats, waxed eloquent about how people rarely have the foresight to know what something may cost them tomorrow when they make choices today.
Professor Calabria Teaches Economics
Why am I talking about Yeats, economics and opportunity cost in a mortgage blog? Because (i) I love the insights into the human soul of Yeats’ poetry, and (ii), totally unrelated, FHFA Director, Mark Calabria, is a former Cato Institute financial regulation policy wonk with a Ph.D. in economics from George Mason University. Cato Institute is the libertarian think tank that gives out the Milton Friedman prize every other year. Knowing that, I am pretty sure that Mr. Calabria also had at least one undergrad econ prof who put TNSTAAFL on the blackboard. Even if that didn’t happen, it’s evident the FHFA Director bought into Milton Friedman’s idea’s big time. Now that he’s in charge of overseeing the GSEs and the forbearance program, Mr. Calabria apparently wants to give millions of Americans an economics lesson in TNSTAAFL too.
What’s the cost to use forbearance?
Believers in free lunch may claim that forbearance really *is* free for borrowers. You get to defer payments you would have owed anyway for up to 12 months. You will only need to pay back the deferred amounts-which you already owed- at a later date, just on a different schedule. Also, the current understanding is that it won’t impact your credit score.[2] So, what’s the downside?
As you may have guessed, opportunity cost is the downside and that cost is soon going to be apparent. Folks enjoying their “free lunch forbearance” (or even those who aren’t, but are glad the government is offering the program in a time of need) don’t realize that they may have also conceded their future ability to borrow against their home equity and/or refinance at a lower rate. The mere availability of forbearance has already made borrowing and accessing home equity more expensive for all of us.
The Opportunity Costs of Forbearance Explained
The vast majority of people using the forbearance program are existing borrowers in desperate need due to COVID-19 related job and income losses. Some, however, are people who just think it’s a free lunch. Regardless of their motivation, interest rates today are lower than ever and likely to stay low for a while. But even with the GSEs still purchasing rate and term refinances in the first month of forbearance (at a 7% discount), if an existing borrower chooses to use the forbearance program and later determines they don’t need it, under the GSEs current guidelines, they will probably forfeit the ability to refinance their loan for at least a year. I say “probably” because this isn’t spelled out anywhere clearly yet, so stay tuned.
Moreover, even at the lowest interest rates ever, it seems highly unlikely that anyone in their first month of forbearance will find a rate and term refinance on a new loan to be worthwhile with a massive 7% loan level pricing adjustment factored in. More than 1 month of forbearance and borrowers are totally shut out. Meanwhile, Rob Chrisman is asking if HELOCs are an endangered species, and have you seen the LLPAs for cash out refi’s for borrowers not in forbearance?!!
So, by using forbearance, a borrower forfeits, at least for some significant period, the ability to enjoy a lower rate or take cash out by refinancing. That’s the opportunity cost most borrowers are missing. To those desperate for help, that opportunity cost shouldn’t matter, but to everyone else, well, cry me a river down by the Salley Gardens.
Explaining Forbearance to Borrowers
Mortgage originators are currently laser-focused on avoiding the risks of forbearance by new borrowers in the loan sale process. In my last two blog posts, I spoke about how FHFA Director Calabria and the GSEs were gouging the mortgage industry with this forbearance program and the moral hazard they created. Stratmor Group published a great guide for how to have the conversation with staff and borrowers about the forbearance program. Beyond that, in the coming months and perhaps years, mortgage lenders will have the unfortunate task of telling perhaps millions of future applicants who used forbearance that they gave up their ability to refinance, cash out or get new financing for a while.
If, on the other hand, you still believe forbearance is “free”, maybe borrowers granted forbearance today will also be granted interest rate reductions and/or cash out by the investors when they finalize their repayment/modification plans in the months to come…, and Milton Friedman will roll over in his grave.
Updated May 19, 2020
On May 19, 2020, FHFA announced that “borrowers are eligible to refinance or buy a new home if they are current on their mortgage (i.e. in forbearance but continued to make their mortgage payments or reinstated their mortgage). Also, Borrowers are eligible to refinance or buy a new home three months after their forbearance ends and they have made three consecutive payments under their repayment plan, or payment deferral option or loan modification.” So, if you asked for forbearance but didn’t use it, no harm/no foul, but if you did use forbearance you’ll have to get current and wait at least 3 months. 3 months is perhaps a small price to pay, but still not “free”, especially if rates rise during that time frame.
[1] On Jonah Goldberg’s, The Remnant Podcast, Sowell admitted to having been a fervent Marxist during his 20’s, but said the reason he became a capitalist was because, “he looked at the data.” Bless him.
[2] Like age, credit scores are just a number. Still, the fact someone used forbearance is noted in the credit file and it’s highly likely to be considered by future creditors.