The Federal Housing Finance Agency (FHFA) took a step last week that may effectively end private transfer fees before the end of the year. 

The agency announced a public comment period on new regulations that would restrict Fannie Mae, Freddie Mac, and the Federal Home Loan Banks (FHLBanks) from investing in mortgages with private transfer fee covenants.  The proposed "Guidance" would extend to mortgages and securities purchased by FHLBanks or acquired by them as collateral for advances, and to mortgages and securities purchased or guaranteed by the Enterprises.

Transfer fees are enabled by covenants on a deed which require a payment to a third party every time property ownership is transferred and are typically 1 percent of the amount of the sale.  For example:  a developer of a condominium complex might put a covenants on each unit deed that would require the initial buyer and every consecutive buyer to pay such a fee to him regardless of the number of times the condo changes hands.  This would provide the developer with a stream of income long after he cashed out of the development with no accompanying requirement to provide any further benefit to that development.  In fact, some of these income streams have actually been securitized by Wall Street.

In another scenario, the fee might accrue to the homeowners association or the guarantee of such fees could be used as an inducement to persuade an opponent - an environmental group for instance - to cooperate with the project.

Establishing such a private fee is not necessarily limited to the developer of the property.  A local government could make it a condition of a zoning change; the owner of land could insist on such future income as part of the purchase price of his land.  Theoretically you could attach a one percent transfer fee covenant to your three bedroom Colonial before you sell it.  And so could the next seller and the seller after that so that each subsequent buyer is increasingly clobbered.  Many transfer fees are set up to endure for 99 years.

FHFA said its concerns with the private transfer fees include that they:

  • Increase the costs of homeownership and reduce liquidity in both primary and secondary mortgage markets;
  • limit property transfers or render them legally uncertain;
  • detract from the stability of the secondary mortgage market, particularly if such fees will be securitized;
  • expose lenders, title companies, and secondary market participants to risks from unknown potential liens and title defects;
  • contribute to reduced transparency for consumers because the fees often are not disclosed by sellers and are difficult to discover through customary title searches, especially after repeated purchases;
  • represent dramatic, last-minute, non-financeable out-of-pocket costs for consumers;
  • deprive subsequent homeowners of equity value; and
  • complicate residential real-estate transactions and introduce confusion and uncertainty for homebuyers.

Acting FHA Director Edward J. DeMarco said "The private transfer fee covenants appear to run counter to the important mission of the housing GSEs (government sponsored enterprises) to increase liquidity, affordability, and stability in the nation's housing finance system.  Encumbering housing transactions with fees that may not be property disclosed may impede the marketability and the valuation of properties and adversely affect the liquidity of securities backed by mortgages on those properties.

The agency said it recognizes that there are a range of actions it can take, including requiring reports on the extent regulated entities are exposed to transfer fee investments, changing seller/servicer guides to identify restrictions on the purchase of transfer fee-encumbered mortgages, creating and enforcing additional representations and warranties or to prohibit the purchase of investment in the mortgages or the revenue generated by the fees.  It appears that FHFA is rejecting all but the final alternative.

The proposed guidance would bring the GSEs and the FHLBanks into line with the Federal Housing Administration (FHA).  HUD's regulations at 24 CFR 203.41 have been interpreted as prohibiting FHA insurance on properties with transfer fees which it defines as "legal restrictions on conveyance." A number of states have also banned the fees and such legislation is under consideration by others.

Advocates of private transfer fees argue that the fees are beneficial when they are used to fund project developments or to enhance community investments through homeowners associations, affordable housing groups, environmental organizations or charitable organizations.  FHFA counters with a concern that such fees are used to fund purely private continuous streams of income and that the fees, even if dedicated to homeowners associations, may not be proportional or related to the purposes for which they were collected.  The draft FHFA guidance does not distinguish between a private transfer fee covenant which supposedly renders a benefit to the property and one which accrues value to unrelated third parties.

The agency also expressed concern that encumbering housing sales with fees that may not be properly disclosed could adversely affect the liquidity of securities backed by mortgages on those properties, a concern that is particularly strong in today's fragile housing market.  There is also concern that disclosures may be insufficient and add costs not fully understood by consumers.  The proposed Guidance also states that "FHFA has found that the typical one percent fee at the time of resale is neither a minimal nor a reasonable mount; further such fees may be excess of one percent.  Such fees increase by a meaningful amount the seller's and potentially the buyer's burden at the time of a property sale.  Expanded use of private transfer fee covenants poses serious risks to the stability and liquidity of the housing finance markets."

The comment period will extend for 60 days after the proposed guidance is published in The Federal Register.  Parties wishing to make comments can get further information at the Federal eRulemaking Portal at http://www,  Reference "Guidance on Private Transfer Fee Covenants (No. 2010-N-11).