Monday, May 1, 2023
Topic: Policy
Content Type: analysis
Keywords:
Redistributing Income Through Housing Policy
- Biden administration rejiggering mortgage fees will benefit higher risk borrowers
- Fees will go down for higher risk borrowers and go up for lower risk borrowers, incentivizing more risky loans
- For every borrower, fees for extremely low down-payment mortgages will fall, inducing more minimally leveraged home loans.
Background
As of May 1, 2023, the two government agencies that guarantee most mortgages in the U.S. will change the fee schedule for U.S. mortgages. These fees are called "Loan Level Price Adjustments", and are added on to a base interest rate for mortgages to account for additional risks of default from the home purchaser due to low credit score or low down payments. While the entire matrix is being redone, the thrust of the changes is to reduce fees for the borrowers that are at the highest risk of default either because their credit scores are low or their down payments are low.
Mortgage News Daily provides a good summary of the changes, including a nice chart showing the changes by down-payment and credit score. Here, I pull out some of the changes for specific credit scores and downpayments and plot them on a graph for a better picture of what's changing.
The graph below shows the fees before (dashed line) and after (solid line) for borrowers whose credit rating is below 620. Notice that before the change, the fee would go down as the down payment increased. This makes sense because higher down payments mean less leverage in a loan and borrowers are less likely to default. Therefore the fees for higher down payments are lower because there is less need for compensation for default risk.
However, under the new schedule, not only are the fees lower for every possible down-payment but one, but the lowest down-payments 0-5% downpayment see the largest decreases in the fee. In the old schedule, the lowest down payments were associated with the highest fees, but in the new schedule the fee is lower for 0-5% down than it is for borrowers putting anywhere between 5 and 30% down!
It should be mentioned that Private Mortgage Insurance (PMI) is an additional fee for loans with down payments below 20% and that those fees increase with smaller down payments and would negate some of the effects, but there's no question that this new schedule is going to mean lower costs for highly leveraged borrowers and low credit score borrowers than were the case previously.
Conversely, for borrowers with higher credit ratings, the picture is less clear. For borrowers putting 5% or less down, the fees go down, creating the same adverse incentives as before, making it cheaper than before, and also potentially cheaper than it would be if the borrower put more down. In the graph, there are three solid lines because the old fee schedule had a single fee for everyone whose ratings were above 740, but the new schedule creates new fee schedules for people between 740 and 759; between 760 and 779; and 780 and up.
For all three groups, the fees are higher than they were if the borrower puts down between 15 and 20%. But the borrowers whose ratings are between 740 and 779 will see higher fees than before if their down payments are between 5 and 25%. Similar to the low credit rating borrowers, the schedule transformed from one that disincentivized low down payments to one that incentivizes both low down-payments and high down-payments but nothing in between.
The Director of the Federal Housing Finance Agency wrote a letter to the Wall Street Journal arguing that the new fee schedule "won't impose higher fees on higher-credit score borrowers than on lower-credit-score borrowers." It's unclean, but it seems this is a case of people talking past each other. Many on the right are saying that costs are going up for high credit borrowers relative to what they were while the fees for low credit borrowers are falling relative to what they were.
Conversely, what the Director is arguing is that the fees for low-credit borrowers are still lower than those for high-credit borrowers, which is how both arguments can be true. In the image below, the fees for high and low credit borrowers shown above are put on the same graph to enable a comparison and verification of the Director's point.
To conclude, the important takeaway from these changes is that, relative to the schedule before, they tend to benefit borrowers with high down payments, very low down-payments, and people with low credit ratings. Presumably they will increase home ownership for people who have difficulty purchasing a home, but those borrowers are more likely to default, so there's clearly a tradeoff. Consequently, this is a policy that should be debated and enacted by a legislature not by an unelected bureaucrat.
Useful Links
Background on Loan Level Pricing Adjustments that are being changedNew LLPA Matrix
Pre-2023 LLPA Matrix
LLPA 2014
LLPA 2016
Updates
House committees demand reversal of fee changesNational Association of Realtors applaud fee changes
National Association of Realtors request reversal