What are Guarantee Fees
Guarantee fees refer to the amount paid to mortgage-backed securities (MBS) providers in return for services rendered. MBS providers like Freddie Mac, Ginnie Mae and Fannie Mae charge lenders guarantee fees for the creation, servicing and reporting of an MBS, as well as for the guarantee that the provider will supplement the MBS to make certain that payments of principal and interest are made even if borrowers default. This payment guarantee is the main component of the guarantee fees. The guarantee fees are often referred to as a type of insurance for mortgage-backed security, although it covers other services as mentioned. Guarantee fees are also referred to as "g-fees."
BREAKING DOWN Guarantee Fees
Guarantee fees are primarily made up of the credit guarantee they provide to the end owner of the MBS, but they also cover the costs of managing and administering the securitized mortgage pools, reporting on the MBS to investors and the Securities and Exchange Commission (SEC) and other back-office tasks. Providers like Fannie, Freddie, and Ginnie help banks by buying mortgages from mortgage companies, commercial banks, credit unions, aggregators and so on. In most cases, however, Fannie, Freddie, and Ginnie are paying for these mortgages by providing them back to the originators in the form of a securitized MBS that the recipient can then choose to sell or keep. The guarantee fee built into the MBS is the revenue generator for the MBS provider and these are ideally sufficient across all products to cover individual mortgage defaults.
The Mortgage Meltdown and Guarantee Fees
Guarantee fees are set on the creditworthiness and size of the underlying mortgage pool. Prior to the 2007–09 mortgage meltdown and financial crisis, guarantee fees were a small deduction of 15 to 25 basis points. In exchange for this small fee, the mortgage originator received a sellable asset while also clearing the loan off the books to free up more credit. This was an excellent deal for lenders, as the MBS providers depended on the information from loan originators to set the guarantee fees. Banks took the opportunity to push the boundaries of who could reasonably be given a mortgage, resulting in NINJA loans and overall market distortion. Unfortunately, the guarantee fees were not being adjusted to reflect this reality, resulting in a massive mortgage meltdown where the U.S. government ultimately had to bail out MBS providers due to their guarantee fees being insufficient to cover the true liability.
Guarantee Fees Post-Meltdown
Guarantee fees have seen a sharp increase since the financial crisis and great recession. Compared to pre-meltdown averages of 15 to 25 basis points, the post-meltdown average is more than double. The Federal Housing and Finance Agency (FHFA) provides an annual analysis of guarantee fees charged by Freddie and Fannie. The FHFA reported an average guarantee fee of 61 basis points on a fixed-rate 30-year mortgage loan issued in 2016. Although guarantee fees generally don’t receive much attention outside of mortgage industry lobbying groups, there were political attempts to make across-the-board increases of an additional 10 basis points through the FHFA to reduce future risks to American taxpayers. These proposed increases were suspended prior to implementation.