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What Does The New “Adverse Market Fee” Mean for Real Estate Investors?

As a real estate investor, the landscape is constantly changing. Markets fluctuate and rates go up and down. COVID has certainly thrown things for a loop. On top of this, on August 12, 2020, Fannie Mae and Freddie Mac announced a new “adverse market fee” that will now go into effect on December 1, 2020.

I’ll break down what this fee means for real estate investors and if it should alter your strategy at all.

Who are Fannie and Freddie?

At a very basic level, Fannie Mae and Freddie Mac are federal U.S. institutions involved in the housing finance system.

When you buy a house with a mortgage, you take a loan from (usually) a bank. If that was the end of the story, banks would become very illiquid, meaning a lot of their money would be tied up in our houses since we pay these mortgages back slowly over 15 or 30 years. This illiquidity would limit banks ability to lend for other causes etc.

Basically, it would gum up the works.

So, in comes Fannie Mae and Freddie Mac. They buy these loans from banks. Now the banks are liquid again.

Then one of two things happen. Fannie and Freddie either keep these loans in their portfolio or they package them into groups called mortgage backed securities or “MBS”. These MBSs are then bought and sold on the market.

With Fannie and Freddie essentially guaranteeing payment on these mortgages, the market attracts more investors and money influxes into the housing market.

This helps keep rates low and the market liquid.

Simple, right?

Are you a homeowner or investor? If so, this matters to you!

This may all seem too far in the weeds to seem important to you.

But if you are buying real estate for a primary residence or as an investor, the ins and out of Freddie and Fannie matter to you a lot.

Remember I said that Freddie and Fannie keep the banks liquid and the secondary housing market attractive and liquid? Remember how I said they do that by essentially guaranteeing that these mortgages/loans are paid on time?

They do this by making sure that they don’t take on any bad investments/mortgages. Duh! If they take on risky mortgages and money isn’t paid, the whole thing falls apart.

This means that Fannie and Freddie set regulations on what type of mortgages they will buy from a bank. A bank therefore sets rules and regulations as to who they will give a mortgage to. They don’t want to offer a loan that Freddie and Fannie won’t buy from them. If you don’t meet these standards, the bank is not giving you a mortgage.

Here’s where the new adverse market fee come into play

So, as of August 12, 2020, Fannie and Freddie decided that they would now charge an extra 50 basis points (0.500%) for mortgage loan origination and for cash out refinance mortgage loans for single family homes.

This is technically a new “loan level pricing adjustment.” Colloquially it’s the adverse market fee. This is because Freddie and Fannie said they implemented it to mitigate the increased risks and costs that they were incurring in this post-COVID market.

Basically, they feel the loans that they are buying from banks are more risky. To limit their risk, they changed the standards required for them to buy a loan from a bank. Now, there is an additional fee to pay. The banks then pass this on to the borrower.

If the borrower can pay an extra few thousand dollars, everyone feels better. The bank will extend the loan. Freddie and Fannie will buy the loan. The wheels keep turning.

Who gets stuck with this extra cost? The mortgagee.

What does this adverse market fee mean for real estate investors?

The effect of the adverse market fee on real estate investors in multifold.

adverse market fee real estate
Another bridge to cross for real estate investors

The most obvious impact is that investors must have more cash on hand to get a mortgage on an investment property.

A 0.5% fee doesn’t seem like a lot. And its not, that’s only $5,000 for a $1 million property. But it can make a difference in absolute terms (more money needed up front) and relative terms (can have an effect on your cash-on-cash return).

Thankfully, these absolute and relative direct impacts on real estate investors from the adverse market fee should be minimal.

If an investor is buying a $1 million rental property, they likely are able to come up with the additional fee. It may affect novice investors beginning with smaller properties more, but again the absolute value of the fee to be paid will be smaller.

In the relative sense, whether a novice or experienced investor, the needle on your cash-on-cash return will not move much over $5,000 if you are selecting investment properties wisely.

But this is not the only effect on real estate investors

There is another part to this adverse market fee. Remember above that the fee also applies to cash-out refinance mortgages on single family homes.

On its face, this may seem inconsequential to real estate investors focused on buying homes. But it is not.

One of the great advantages of real estate investing is the leverage available to help grow your portfolio. You only invest a portion of the purchase price and get to enjoy all of the benefits.

A great way to use this leverage is to harness the lazy equity sitting in any investment properties that you already own using a cash-out refinance. Then that money can then buy more investment properties while your tenants continue to keep paying off the new mortgage on the old properties with their monthly rent.

Further, some also advocate for using cash-out refinance mortgages of your primary residence as seed money to begin building your real estate business. I’m not here to argue the pros and cons of this, but it os a strategy.

Regardless if you use a cash-out refinance mortgage for an investment property or primary residence, this adverse market fee now will hit you twice.

First, it will decrease the amount of equity you can harness from your cash-out refinance on the front end. Then it will increase the amount of cash down that you need when you purchase a new property on the back end.

Thus, the impact on real estate investors just doubled.

Should you change your real estate investing strategy?

This new adverse market fee does change the real estate investing landscape.

But the good news is that it need not change your real estate investing strategy.

Hopefully, you are analyzing properties using the numbers rather than using emotion. Cash-on-cash return is my metric of choice but certainly not the only or necessarily the best way to vet properties.

Whatever method you use, make sure to include these new fees in your analysis. If you are planning on a cash-out re-fi as part of your down payment, make sure you know how much you can get including this new fee.

If the numbers don’t add up for a potential property after incorporating the fees, don’t buy the property. When they do add up, then you can move ahead with confidence.

Let me show you my personal real estate investing strategy so you can get started!

What do you think? Will the new adverse market fee by Freddie and Fannie change how you invest? Have any fees or unexpected conditions affected one of your real estate investments in the past? Did I miss anything? Leave a comment below!

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    Jordan Frey MD, a plastic surgeon in Buffalo, NY, is one of the fastest-growing physician finance bloggers in the world. See how he went from financially clueless to increasing his net worth by $1M in 1 year and how you can do the same! Feel free to send Jordan a message at [email protected].

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