Preying on Veterans, Mortgage Brokers Could Hurt Big Bond Market

(Bloomberg) -- Mortgage brokers and lenders appear to be skirting new rules that are meant to protect U.S. military veterans from abusive loan practices.

In September, there was a clear sign that someone might be preying on homeowners. Roughly 5,000 veterans and active military members took cash out of their homes by refinancing loans, according to estimates from Ginnie Mae, a government-owned corporation whose job is making mortgages more affordable. The figure startled Ginnie officials because with interest rates rising, they expected about 50 borrowers to pull equity from their homes.

Either a lot of homeowners were desperate for money -- and willing to pay a higher monthly rate to get it -- or they were being hounded to refinance.

“We believe brokers and some lenders are pushing veterans into it,” Michael Bright, Ginnie’s chief operating officer, said in an interview. “We are aware of this, we are upset about this, and we will take steps to fix this.”

Ginnie Securities

If left unchecked, surging refinances might lead not only to higher borrowing costs for consumers, but also disruptions in the $2 trillion market for Ginnie securities, which helps fuel several federal housing programs.

Big investors, including Goldman Sachs Group Inc. and Pacific Investment Management Co., have warned privately about the jump in refinances and indicated that it’s prompted them to pull back from purchasing Ginnie bonds, according to people familiar with the matter.

Spokesman for Goldman and Pimco declined to comment.

Concern that some lenders were encouraging veterans to engage in serial and unneeded refinances prompted lawmakers to crack down on the practice -- known as churning -- earlier this year. But in imposing new constraints on the industry, Congress didn’t place any restrictions on service members using their homes as ATMs.

Skittish Investors

Cash-out refinances by veterans are now rising, and Bright said excluding such transactions from the legislation might be triggering the uptick. One potential consequence: thousands of service members could be stuck with diminished ownership stakes in their properties and loans they can’t afford.

Bright said there are also signs already that investors are pulling back from Ginnie mortgage bonds, and he’s worried that may continue if refinances aren’t addressed.

Ginnie’s role in the housing market works like this: Loans insured by federal agencies, including the Federal Housing Administration and the Department of Veterans of Affairs, are packaged into bonds that Ginnie guarantees. The backstops enable lenders to give borrowers more generous terms, such as not requiring down payments.

When Pimco and other firms purchase Ginnie securities, they make assumptions about how quickly homeowners will refinance. If borrowers swap their mortgage out for a new one more quickly than anticipated, bond investors risk losing their expected yield. Such factors can make Ginnie securities less attractive, which can impact prices.

Ginnie Investigation

Ginnie is trying to determine whether any specific brokers or lenders are generating high fees by pushing veterans to take out new loans. To limit transaction volume, the regulator might put limits on how quickly military members can refinance their mortgages.

It’s also considering not allowing veteran loans to be packaged into Ginnie bonds if the they result in consumers pulling any equity out of their homes. If Ginnie took that step, such loans could probably still be included in what’s known as custom pools of securities. But those bonds would probably be less attractive to investors.

Bright said he expects Ginnie to take action as soon as next month. Earlier this year, the regulator punished some lenders in a broader crackdown on alleged refinance churning.

In a May overhaul of the Dodd-Frank Act, Congress included provisions designed to curtail repeated refinances of veterans’ loans. Among the changes are requirements that service members recoup fees from a refinance within three years and that new loans reduce a borrower’s interest rate by at least half a percentage point in most cases. The legislation gave veteran cash-out refinances an exemption from the rules.

©2018 Bloomberg L.P.