How the US is subsidizing high-risk homebuyers — at the cost of those with good credit

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By Thomas Barrabi

April 16, 2023 | 4:23pm

A little-noticed revamp of federal rules on mortgage fees will offer discounted rates for home buyers with riskier credit backgrounds — and force higher-credit homebuyers to foot the bill, The Post has learned.

Fannie Mae and Freddie Mac will enact changes to fees known as loan-level price adjustments (LLPAs) on May 1 that will affect mortgages originating at private banks nationwide, from Wells Fargo to JPMorgan Chase, effectively tweaking interest rates paid by the vast majority of homebuyers.

The result, according to industry pros: pricier monthly mortgage payments for most homebuyers — an ugly surprise for those who worked for years to build their credit, only to face higher costs than they expected as part of a housing affordability push by the US Federal Housing Finance Agency.

“It’s going to be a challenge trying to explain to somebody that says, ‘I worked my whole life for high credit and I’ve put a lot of money down and you’re telling me that’s a negative now?’ That’s a hard conversation to have,” one worried Arizona-based mortgage loan 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 from mortgage companies and CEOs [telling] me how unbelievably shocked they are by this move.” 

The tweaks could further complicate the strenuous mortgage application process and add more pressure on 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 is hovering at 6.27% as of last week — up from about 5% one year ago and more than twice as high as it was two years ago, according to Freddie Mac data.

Under the new rules, high-credit buyers with scores ranging from 680 to above 780 will see a spike in their mortgage costs – with applicants who place 15% to 20% down payment experiencing the biggest increase in fees.

“This was a blatant and significant cut of fees for their highest-risk borrowers and a clear increase in much better credit quality buyers – which just clarified to the world that this move was a pretty significant cross-subsidy pricing change,” added Stevens, who is also the former CEO of the Mortgage Bankers Association.

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

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

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

Meanwhile, buyers with credit scores of 679 or lower will have their fees slashed, 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 1.75% fee discount – a decrease from the old fee rate of 3.50% for that bracket.

When absorbed into the long-term mortgage rate, that equates to a 0.4% to 0.5% discount.

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 charge 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 who warned it would be difficult to implement.

After the pushback, FHFA announced last month 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 deploy the fee.”

The LLPA fee changes are still slated to take effect on May 1.

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

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

“The timing of this is troubling,” Pete Mills, senior vice president of residential policy at the MBA, told The Post. “As we start to hit the spring home buying season, home purchases are demonstrably impacted by the rate increases over the past year. The timing of this is not ideal.”

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

Asked about concerns that the changes will hurt high-credit buyers, an FHFA official told The Post the agency was “tasked with ensuring [Fannie and Freddie] fulfill their role in any market condition,” adding that shifts in long-term mortgage rates are a far bigger factor in determining finance conditions in the US housing market.

“The latest recalibration to the pricing 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 mortgage loans. They do this in part by using the “cross-subsidization” model, in which some borrowers are charged slightly more for loans while others are charged less.

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

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

The agency asserts the LLPA changes will help maintain financial health at Fannie and Freddie — a key element of its responsibility as conservator.

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