My phone, email and social media has been lit up since the new Loan Level Pricing Adjustments (LLPA’s) for loans sold through Fannie Mae and Freddie Mac went into effect on May 1. After this date the fee to sell a mortgage to Fannie and Freddie was increased by .375% to borrowers with higher credit scores to offset the lowering of up-front costs to those with lower credit scores.

LLPA’s were put in place years ago to compensate lenders for the higher risk of delinquencies and defaults that occurred with borrowers who did not demonstrate proper management of credit through lower credit scores with the financial strength to manage payments and protect their equity by having made a sizable down payment. The lower the credit score and lower the down payment, the higher the interest rate. This is called “risk-based pricing”.

Here we are once again finding ourselves collectively gathering in our like-minded tribes to cry “foul” or “not fair” or even worse.

To understand exactly what is going on after May 1, let’s look at a real-life example.

Let’s assume that we are purchasing a home for $300,000 and putting 5% down ($15,000) borrowing $285,000 at a rate of 6.5% for 30 years with a principal and interest payment of $1,801.

Prior to May 1, a borrower with a credit score 740 or higher would pay a LLPA of .25% in loan fee which adds $712 to their closing costs. (.25% X $285,000). After May 1 the LLPA for 740 credit scores was increased to .625%, or $1,781 (.625 X $285,000.) This additional $1,069 in fee income ($,1781 – $712) is being used to subsidize a lower LLPA adjustment for those with lower credit scores, allegedly. Make no mistake, Fannie and Freddie will profit nicely from this change, more on that later.

Prior to May 1, those with a credit score of 639 and below paid an LLPA of 3.25% for a 5% down $285,000 mortgage or $9,262 ($285,000 X 3.25). After May 1 the LLPA was lowered 1% to 2.25% or $6,412, a savings of $2,850 in closing costs.
Thus far in this example we have shown that in order for a low credit score borrower to get the same rate (6.5%) and payment ($1,801) as a high credit score borrower, they would have to pay $4,631 more in loan fees ($6,412 low credit score fee – $1,781 high credit score fee).

The goal of increasing LLPA’s to those with higher credit scores, 779 or lower, is to offset the new lower LLPA’s for those with lower credit scores and make purchasing a home more affordable. In reality most borrowers don’t have the resources to pay these fees at settlement and even if they did, I would advocate for the alternative of paying a higher interest rate to offset the higher loan fees, or points.

The higher loan fees, or points can be offset by increasing the interest rate through up-front credits or premium pricing that the lender can use to offset the higher fees, or LLPA’s.

To offset an LLPA of 2.25% the interest rate would need to be increased to 7% which would increase the monthly payment to $1,896 or $95 more than the payment at 6.5%. For borrowers with limited funds this is the price they have to pay. But would it also make sense for borrowers who do have the resources to pay the loan fee? The answer is no, it does not make sense to pay additional loans fees to get a lower interest rate. Follow my math.

In this example the worst payment is the higher payment at 7% and a payment of $1,896, with an option of paying $6,412 to save $95 per month. To break even and recoup the $6,412 in fees, it would take 67 months ($6,412 divided by $95 per month savings). The likelihood of you having a 7% mortgage in 5 ½ years is slim to none. It is most likely that you will have the opportunity to refinance to a lower rate, possibly within the next two years when rates drop to the lower 5% range.
Regardless of how a borrower would pay the “penalty” for lower credit scores, either higher closing costs or a higher interest rate, they will also have to pay mortgage insurance because the down payment is less than 20%. In the case of our 5% down example of $285,000 mortgage, the monthly premium for conventional mortgage insurance would be $194 if credit score is 660. It jumps to $218 if the credit score is 640.

If you are looking to purchase a home and you have credit scores in the low to mid-600 range, you should consider other loan programs like USDA, FHA, and VA. The interest rate on these programs can be as much as .5 to .75 lower than conventional loans, plus monthly mortgage insurance premiums are lower than conventional loans. In the case of VA loans there is no monthly mortgage insurance premium.

To qualify for a VA loan, you must be a veteran. To qualify for USDA, your household income must be less than $121,350 for a family of four or less and $160,200 if you are a family of five or more. FHA loans have no special eligibility qualification requirements.

Monthly mortgage insurance payments are .55% for FHA loans and .35% for USDA loans. For our $285,000 loan the monthly premium would be $131 for FHA and $83 for USDA, both of which are significantly lower than the $194 or $218 for conventional Fannie and Freddie loans.

I must also note that in addition to paying the monthly mortgage insurance premiums for USDA and FHA, there are required upfront mortgage insurance premiums of 1.0% for USDA and 1.75% for FHA. Both of these are financed and added to the loan amount of $285,000. Regardless of this increase in loan amount the combination of lower interest rates and mortgage insurance premiums makes it quite clear that very few lower credit score borrowers will benefit from lower LLPA’s. They will use a different loan program altogether.

There are many other moving parts with this increase of LLPA’s for higher score borrowers to subsidize a decrease of LLPA’s for lower credit score borrowers. I do not want to go too deep into the weeds with individual credit score bracket changes because I believe my interpretation captures the essence of the issue.

By this action the Biden administration is furthering its agenda of making the purchasing of a home more affordable. In response to the doubling of interest rates in the last 14-16 months the LLPA change is a lot of noise with very little action.
A more significant step was taken on March 20, when the FHA lowered the annual mortgage premium from .85% to .55%. Prior to March 20th the premium would have been $70 more or $201 than the $131 in our example.

Under the guise of making housing more affordable this change will have no positive impact for those with lower credit scores purchasing a home, other loan programs will be a better option. But this change will have a significant impact on Fannie Mae and Freddie Mac’s bottom line.

Regardless of all the moving parts of this change and the politics of those doing the right thing paying for those who don’t, the bottom line is Fannie and Freddie will rake in .375% more revenue.

Fannie Mae’s volume of single-family loans dropped from $1.4 trillion in 2021 to $615 billion in 2022. Freddie Mac dropped from $1.29 trillion to $619 billion. Basically, both GSE’s (Government Sponsored Enterprises) saw a 50% drop in loan volume.
Assuming each GSE collects .375% in additional revenue on $500,000,000,000 ($500 billion) in loan volume, they would receive $1.875 billion in additional annual revenue they didn’t have before this change. This is my unscientific estimate of the net effect of the LLPS change to make my point. (To get this number I had to get Google to do the math, I don’t have a calculator that would allow me to put in 11 zeros.)

Make no mistake, this action is the result of a larger political agenda (call it what you like) where one group of people is pitted against another group of people for the benefit of those less fortunate at the expense of those more fortunate. In this case it is credit scores and the cost of credit through Loan Level Pricing Adjustments (LLPA’s).

It could just as easily be liberal’s vs conservatives, Republicans vs Democrats, right to lifer’s vs abortion rights advocates, gun control vs gun rights, student loan borrowers vs the no “free lunchers”. Call them what you will, and pick any issue. We are in a never-ending spiral of “fitting in” with our beliefs and believing so strongly we consider those with opposing opinions to be the enemy without reason.

The LLPA adjustments serve a political agenda pure and simple. Under the guise of “equitable” access to mortgage credit, the administration is assuming that those with low credit scores have lower income and are being penalized because they do. Newsflash President Biden! There are a lot of high-income individuals with low credit scores. Believe me! LLPA’s were implemented in order to compensate lenders for the higher likelihood of a borrower defaulting. Data has shown that those who manage credit less appropriately than those who do are more likely to be late on their payments and possibly default.
All of the sudden, credit scores have become another column on the “equity” score card. The net result is that very few if any lower score credit borrowers will benefit because in most cases there are better alternatives. Conventional loans through Fannie and Freddie will be the last program they consider if they consider it at all. Personally, I never consider or recommend a Conventional loan to a person with low credit scores.

Although this change was made effective on loans delivered to the GSE’s after May 1, this change has been in lenders pricing for 60-90 days in anticipation of its effective date. Loans are delivered about four weeks after they have closed. The loan could have been originated as early as late February to early March. It was not like you saw a loan fee increase of .375% in May from the pricing on April 30.

Borrowers with lower credit scores are paying for their transgression potentially thousands of dollars more at settlement to keep the same rate as higher score borrowers, or they will pay a higher interest rate and payment to offset the additional costs.

I predict that Fannie and Freddie will see very little if any increase in volume of loans to borrowers with credit scores below 660. The unintended consequence of more revenue is a good one for Fannie and Freddie.

Mr. Rowe is Vice President/Lending for Bay Capital Mortgage Corp. with offices in Easton and Annapolis. He has lived in Caroline for his entire life and supports the county by volunteering in a variety of ways. He currently lives near Greensboro with his wife Jeanne and daughter Kelsey.