Do new rules punish good credit?

This week, Fannie Mae and Freddie Mac began charging new credit fees for mortgage interest rates.  Are they really penalizing borrowers with good credit and large down payments?

Risk Based Pricing

Before we can discern what's really going on, we must understand risk-based pricing.  Every interest rate comes with a cost.  The lower the rate, the higher the cost.  That cost is referred to as discount points.  One "point" equals 1% of a borrower's loan amount.  And these points vary based on market conditions and characteristics (or risk factors) of the loan.

For example, a borrower who is getting a home loan for a manufactured home will pay more for his interest rate than someone buying a stick-built home.  A mortgage interest rate for an investment property will cost more than the same rate for a home that will be a primary residence.  Other factors that play into risk-based pricing include the down payment (or loan to value) and credit score.

Previous Price Adds

For decades, these pricing factors remained largely unchanged - especially as they relate to down payment and credit score.  Lenders use credit score "tiers" to determine pricing.  Borrowers in the same tier (with the same down payment) pay the same price.

Until now, the top credit tier has been 740.  As long as a customer had a score of 740 and above, they enjoyed top-tier pricing.  Someone with a 742 credit score paid the same price as the person with an 842 credit score.

What's Changing Now?

The biggest change to the new credit fee structure is that Fannie and Freddie have added additional credit tiers for high scores.  740 is no longer king!  New credit tiers have been added for scores of 760-779 and 780 and above.  Customers in those top credit tiers with large down payments are paying roughly the same credit fees as they were before - or even slightly better. 

So why is the media reporting that borrowers with big down payments and high credit scores are subsidizing high-risk homebuyers?  Because customers in the lower credit score tiers will see the biggest improvement under the new system.  Across the board, scores of 679 or less will see lower credit fees.  A customer with a 640 score and 25% down will pay 1.25% less for their interest rate under the new system.

To be clear, this does not mean borrowers with low credit scores are getting a better deal than borrowers with high credit scores.  Credit challenged borrowers still pay much higher credit fees!  Borrowers in this category just saw the biggest improvement to credit fees over the old system.

In addition, credit fees are being completely eliminated for most first time home buyers with income that doesn't exceed 100% of area median income (or 120% of AMI in high-cost areas).  That's a huge advantage for low- to moderate-income first time buyers.  Yay!

Who are the biggest losers under the new scheme?  Borrowers in the "middle" credit tiers (720 to 759) with smaller down payments.  For example, a buyer with a 740 credit score and 15% down will now pay 1.0% more for their interest rate.  That bites.

Important Notes

• These are changes to price - not interest rate.  When we say credit fees increased by 0.25%, we're referring to the price or discount points paid for any one interest rate.  Discount points are a one-time fee paid at closing.  A person borrowing $400,000 who pays 0.25% more for their interest rate is paying $1,000 more at closing.
   
• This only applies to loans securitized by Fannie Mae and Freddie Mac.  Government loans (FHA, VA, and USDA) and jumbo loans are not affected.
   
• Even though Fannie and Freddie's implementation of the rule began May 1, lenders implemented these changes months ago.  After a loan closes, it takes weeks (if not months) for the loan to be sold.  Lenders began charging these fees long ago since those loans wouldn't be sold until after the May 1 implementation date.  In other words, it already happened, and you probably didn't even notice.

Get the Best Price

What can you do to get the best price possible on your home loan?

• Maximize your credit score.  The biggest factor in determining credit scores is timely payments.  But the next biggest factor is credit utilization.  I often see customers who have never had a late payment in their lives but have several credit cards with balances close to the credit limit.  These customers usually have credit scores well below 700.  To have the highest score possible, keep each credit card balance at 30% of less of the credit limit.
   
• Work with someone who understands credit fee matrices and can help you structure your loan to get the best price.  Sometimes paying off a small debt or borrowing slightly more (or less) could save considerable cash at closing.  Make sure you're working with a loan officer who will consider all your options.