A federal regulator is proposing that five states with higher than average foreclosure costs pick up part of the tab for those foreclosures through higher Fannie Mae and Freddie Mac guarantee fees (g-fees).  According to a press release late yesterday from the Federal Housing Finance Agency (FHFA) the size of the g-fee adjustments "are intended to reflect the disparity in costs as compared to the national average."

Under the proposal, the two government sponsored enterprises (GSEs) would hike fees between 15 and 30 basis points on lenders in Connecticut, Florida, Illinois, New Jersey, and New York.  Those states each have considerably longer time frames to obtain marketable title than the national average as well as costs that range between 9 and 18 percentage points above the national average. 

FHFA said that the wide variations among states in the costs the GSEs incur from mortgage defaults are attributable to three factors:

1.    The length of time needed to secure marketable title to the property;

2.    Property taxes that must be paid until marketable title is secured, and

3.    Legal and operational expenses during that period.

Twenty one states have costs above the national average and several have costs above those in the five targeted states, however it appears to be the time frame that is driving the disparity.

The agency said it recognizes that the GSEs have calculated state-level differences on a combination of their own experience and estimation and that actual costs in the future may vary over time.  "Because of this variability, FHFA's planned approach focuses on five states that are clear outliers among states in terms of their default-related costs."  The estimations also do not include any forward-looking impact of recently-enacted state and local laws that might increase costs.

The increased fees would be charged to lenders as a one-time upfront payment on each loan acquired by the GSEs and can be passed onto the borrower as an adjustment to the interest rate on the borrower's loan.  FHFA said dividing the upfront fee by five would approximate the impact of the fee on a rate, e.g. a 15 basis upfront fee would result in a 3 basis point increase in rate or $3.50 per month on a $200,000 loan.

To determine the fee increases FHFA looked at the number of days it takes to obtain a marketable title through foreclosure, the average per-day carrying cost in the state, and the expected national average default rate on single-family mortgages acquired by the GSEs.  It is assumed that loans originated in each state will default at the national average default rate.

In the table below the "Cost per Day Relative to the National Average" is the estimated per-day carrying cost per dollar of unpaid principal balance where the national average equals 100 percent.  The rank assigns the lowest numbers to the lowest cost areas.

The planned approach focuses on the small number of states that have expected total default-related carrying costs that significantly exceed the national average, and thus cause the greatest increase in average loss given default.  The state between one and a half and two standards deviations from the mean, Illinois, would have an upfront fee of 15 basis points while New York with more than three standard deviations from the mean would have an upfront fee of 30 basis points.  The three states in the middle, Florida, Connecticut, and New Jersey, would have an upfront fee of 20 basis points.

FHFA goes on to say that if those state were to adjust their laws and requirements sufficiently to move their foreclosure timelines and costs more in line with the national average, these planned fee hikes would be lowered or eliminated.  The fee adjustments recognize "that unusual costs associated with practices outside of the norm in the rest of the country should be borne by the citizens of that particular state rather than absorbed by borrowers in other states or by taxpayers."

It should be noted that all five of the states affected by the proposed increases use a so-called judicial process of foreclosure.  Under this process it is necessary to obtain court approval at some point before the foreclosure is completed and in judicial states as a whole the backlog of foreclosures is currently about three to four times that in non-judicial states.  

FHFA is opening a 60-day comment period on the proposed adjustments and is particularly seeking comments on the following:

1.       Is standard deviation a reasonable basis for identifying those states that are significantly more costly than the national average?

2.       Should finer distinctions be made between states than the approach described here?

3.       Should an upfront fee or an upfront credit be assessed on every state based on its relationship to the national average total carrying cost, such that the net revenue effect on the GSEs is zero?