How the US is subsidizing high-risk homebuyers – at the expense of those with good credit

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Of Thomas Barrabi

April 16, 2023 | 16:23

A little-noticed overhaul of federal mortgage fee rules would offer discounted rates to homebuyers with riskier credit backgrounds — forcing homebuyers with higher credit to foot the bill, The Post has learned.

Fannie Mae and Freddie Mac will adopt fee changes known as loan level pricing adjustments (LLPAs) on May 1[ads1] that will affect mortgages originated by private banks across the country, from Wells Fargo to JPMorgan Chase, effectively adjusting the interest rates paid by the vast majority of home buyers .

The result, according to industry professionals: more expensive monthly mortgage payments for most homebuyers — a nasty surprise for those who have worked for years to build their credit, only to face higher-than-expected costs as part of a squeeze on housing affordability from US Federal Housing Finance Agency.

“It’s going to be a challenge trying to explain to someone who says, ‘I’ve worked my whole life for great credit and I’ve put a lot of money down, and you’re telling me it’s negative now?’ It’s a difficult conversation to have,” a concerned Arizona-based mortgage originator told The Post.

“It’s unprecedented,” added David Stevens, who served as Federal Housing Administration commissioner during the Obama administration. “My email is full of credit unions and CEOs [telling] me how incredibly shocked they are by this move.”

The adjustments could further complicate the arduous mortgage application process and add more pressure to a core segment of buyers in a housing market already in the midst of a major downturn, the experts added. The average 30-year mortgage rate stood at 6.27% as of last week — up from about 5% a year ago and more than double what it was two years ago, according to data from Freddie Mac.

Under the new rules, high-credit buyers with scores from 680 to above 780 will see an increase in mortgage costs – with applicants putting down 15% to 20% down payments seeing the biggest increase in fees.

“This was an obvious and significant cut in fees for their highest risk borrowers and a clear increase in much better credit quality buyers – which just made it clear to the world that this move was a pretty significant cross-subsidy price change,” Stevens added. who is also the former managing director of Boligkredittforeningen.

LLPAs are upfront fees based on factors such as a borrower’s credit score and the size of the down payment. The fees are usually converted into percentage points that change the buyer’s mortgage rate.

Under the revised LLPA rate structure, a homebuyer with a 740 FICO credit score and a 15% to 20% down payment will face a 1% surcharge — a 0.750% increase compared to the old fee of just 0.250%.

When absorbed into a long-term mortgage rate, the increase equates to a little less than a quarter of a percentage point in the mortgage rate. On a $400,000 loan with a 6% mortgage rate, this buyer could expect their monthly payment to increase by about $40, according to Stevens’ calculations.

Meanwhile, buyers with credit scores of 679 or lower will have their fees cut, resulting in more favorable mortgage rates. For example, a buyer with a 620 FICO credit score with a down payment of 5% or less gets a fee discount of 1.75% – a reduction from the old fee rate of 3.50% for that bracket.

When absorbed in the long-term mortgage rate, it equates to a discount of 0.4% to 0.5%.

The FHFA-ordered overhaul of LLPAs affects purchase loans, limited cash-out refinances and cash-out refinance loans.

The revamped pricing matrix also includes the controversial addition of a new fee for buyers with debt-to-income ratios above 40% — a convoluted measure that drew immediate pushback from the Mortgage Bankers Association and other industry groups that warned it would be difficult to implement . .

After the setback, the FHFA announced last month that it would delay the rollout of the debt-to-income fee until at least Aug. 1 — a move it said would “ensure a level playing field for all lenders to have sufficient time to implement the fee.”

The LLPA levy changes are still scheduled to come into force on 1 May.

The fee structure changes are the latest of several moves by FHFA aimed at increasing affordability for what the agency calls “mission borrowers” — defined as first-time buyers, low-income borrowers and applicants from underserved communities.

Last year, FHFA eliminated upfront fees for first-time home buyers that are at or below 100% of the area median income, or 120% in areas identified as “high cost.” The agency also raised upfront fees on holiday homes and some larger mortgages.

“The timing of this is troubling,” Pete Mills, senior vice president for housing policy at MBA, told The Post. “As we begin to enter the spring home buying season, home buying is demonstrably affected by the rate increases of the past year. The timing for this is not ideal.”

“Most borrowers” are likely to see a modest price increase as a result of the fee changes, according to Mills.

When asked about concerns that the changes would hurt buyers with high credit, an FHFA official told The Post that the agency was tasked with ensuring [Fannie and Freddie] fulfill its role in all market conditions,” adding that changes in long-term mortgage interest rates are a far greater factor in determining financial conditions in the US housing market.

“The latest recalibration of the price framework that FHFA announced in January 2023 is minimal, by comparison, and maintains market stability,” the FHFA official said in a statement.

Fannie and Freddie are government-backed entities that buy up loans from mortgage lenders and either hold them as assets or resell them as mortgage-backed securities. Both have been in federal conservatorship since the housing market imploded during the Great Recession.

The two firms are bound by their charters to help improve access to affordable mortgages. They do this in part by using the “cross-subsidisation” model, where some borrowers are charged a little more for loans while others are charged less.

Overall, buyers with lower credit will still pay more in LLPA fees than buyers with high credit – but the latest changes will close the gap.

The official said the LLPA changes will result in an average price increase of just three to four basis points, or 0.03% to 0.04%, across the spectrum of mortgage borrowers – the equivalent of a few dollars per month.

The agency argues that the LLPA changes will help maintain the financial health of Fannie and Freddie — a key element of its responsibilities as conservator.

“These changes to upfront fees will strengthen the safety and soundness of businesses by improving their ability to improve their capital position over time,” FHFA Director Sandra Thompson said in a statement earlier this year.