With interest rates hitting historic lows, why will property owners in Colorado ski towns from Steamboat to Telluride  get much higher interest rates than Denver?  (Do you know where I took this pic?)  Why will locals in the resort communities get hit hardest?  What changed in December to cause the spike in rates?  Fannie Mae, the largest buyer of mortgages, changed its rules to make it clearer that it won’t back certain loans in high-rent vacation areas like many Colorado ski towns.

How do Mortgages work?

Before going into the change from Fannie Mae, it is important to understand how the mortgage market works.  The United States mortgage market is unique.  For the vast majority of mortgages, Banks, brokers, or other lenders originate loans and immediately sell the note to either Fainnie Mae or Freddie Mac.  The two government sponsored entities (GSEs) buy mortgages, package them via securities, and sell these securities to various investors.  At the same time Fannie/Freddie and ultimately taxpayers guarantee these mortgage pools which enables very low pricing as the government holds the majority of risk in the security.  This system has enabled the US to have rock bottom rates and offer a 30 year mortgage product.

Why is the move by Fannie Mae and Freddie Mac so important?

Fannie Mae last month changed its rules to make it clearer that it won’t back certain loans in high-rent vacation areas, with Freddie Mac taking similar steps that go into effect next month. When a project as a whole functions more like a vacation rental resort, the building is ineligible for Fannie financing, and mortgages secured by units in that project are also ineligible, the company says. Essentially many condo projects will no longer be eligible for backing by Fannie/Freddie.  After reading the guidelines it seems like there is considerable ambiguity on what properties are no longer eligible for backing.  Many banks are taking this as a warning sign and pulling back from lending in many of these areas as they don’t want to get stuck holding a large quantity of loans on their books

With Fannie/Freddie guaranteeing the vast majority of mortgages even on second homes their recent announcement will ripple through the resort markets.  With Fannie/Freddie not backing mortgages, these loans will be treated like jumbo loans with banks holding/securitizing these loans.  This will substantially increase rates, availability, and lending options.

The Jumbo market as a roadmap: 3 impacts to Colorado ski town real estate loans

With Fannie not backing many mortgages in ski towns, the jumbo market (loans above Fannie limits) provides a good roadmap as to the impact.  Banks will take on risk and as a result three major changes will occur:

1. Higher rates: Currently rates on jumbo loans are ½ to ¾% higher than a 30 year mortgage, I suspect the same will happen on many of the condos that Fannie/Freddie will no longer insure.
2. Stricter underwriting standards: With no government backing, banks/lenders will increase underwriting to decrease their risk.  This will include higher credit score requirements, increased income, and decreased debt.
3. More Adjustable Products (ARM): Without the government lenders will be stuck with the future interest rate risk.  As a result you will see more ARM products like a 5/1 or 7/1 where a mortgage is fixed for 5 years and then adjusts.  This is how the jumbo market currently functions with 30 year fixed mortgages not as prevalent.

What will the Fannie/Freddie changes have on real estate prices in Colorado ski towns?

As the new changes by Fannie Mae are implemented there are two primary changes that will occur in Colorado mountain real estate.

1. Make the mountains more elitist/expensive: By no means are Colorado ski towns a beacon of affordability today.  Unfortunately these changes will make the resort communities even more elitist as underwriting standards are increased, down payments requirements are increased, and banks implement stricter underwriting to minimize risk.  These changes will disqualify a group of buyers that might have been prospective purchasers under the old guidelines.  Many of the impacted buyers will be locals as they continue to get priced out of the market.
2. Minimal impact on prices: I don’t think there will be an impact on pricing one way or the other.  The real story in the mountains is lack of inventory.  Many destination buyers will continue to demand the Colorado ski lifestyle which will keep prices from falling.  Furthermore the majority of buyers (for example 66% in Steamboat) are cash buyers which will not be affected by the changes.

Summary:

I thought it was an interesting announcement that Fannie/Freddie was no longer backing mortgages in certain resort properties.  Unfortunately this announcement further highlights the disconnect between Washington and what happens in real life.  The real life implications of this rule is that locals will be hurt hardest by the new initiative which is counter to Fannie’s mission of providing affordable housing.  This could be easily fixed if there was an exception for primary residences.  Regardless of the changes, many buyers of condos will be in for a shock with stricter underwriting and higher mortgage rates.

Resources/Additional reading

1. https://www.fanniemae.com/about-us/what-we-do
2. https://www.wsj.com/articles/fannie-freddie-tighten-rules-for-condos-in-vacation-locales-11610208000?mod=mhp
3. https://www.foxbusiness.com/real-estate/fannie-freddie-tighten-rules-condos-vacation-locales

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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