Good Is Not Always Great: Why Having Good Credit Could Cost You More On A Home Mortgage
May 19, 2023
For many people, owning a home is a major financial goal. It's a symbol of success, a place to build a life and a long-term investment. But buying a home can also be expensive, and for most people, it requires a mortgage. When you're shopping for a mortgage, you'll find that there are a lot of fees and costs associated with the loan. One of the most important fees is the Loan Level Price Adjustment (LLPA).
LLPA’s are fees that are charged by Fannie Mae and Freddie Mac, the Government-Sponsored Enterprises that back many of the mortgages in the United States. The fees are charged upfront and are based on a number of factors, including the borrower's credit score, the size of the down payment, and the type of home being purchased. The fees can range from 0.25% to 3% of the loan amount.
Beginning this month, the fees for loans backed by Fannie Mae and Freddie Mac will be adjusted. The changes are the result of new federal rules that are designed to ensure that the fees charged by Fannie Mae and Freddie Mac are fair and equitable.
The new rules are complex, but here's what you need to know:
Fees will be based on risk
Under the new rules, the fees charged by Fannie Mae and Freddie Mac will be based on risk. Borrowers who are deemed to be higher risk will pay higher fees, while borrowers who are deemed to be lower risk will pay lower fees.
Factors that will be taken into account include the borrower's credit score, the size of the down payment, and the type of home being purchased. Borrowers with higher credit scores and larger down payments will be deemed to be lower risk and will pay lower fees. Borrowers with lower credit scores and smaller down payments will be deemed to be higher risk and will pay higher fees.
The changes could impact how much you pay
If you're in the market for a mortgage, the changes to the LLPA’s could impact how much you pay. Borrowers with higher credit scores and larger down payments may pay less in fees under the new rules, while borrowers with lower credit scores and smaller down payments may pay more.
It's important to note that the changes to the LLPA’s are just one factor that can impact the cost of a mortgage. Other factors, such as interest rates and closing costs, can also impact the total cost of the loan.
The changes are designed to be fair and equitable
The changes to the LLPA’s are designed to be fair and equitable. Under the old system, borrowers with lower credit scores and smaller down payments often paid more in fees, even if they posed no greater risk to the lender than borrowers with higher credit scores and larger down payments.
The new rules are designed to ensure that fees are based on risk, rather than arbitrary factors like credit scores and down payment sizes. This means that borrowers who pose less risk to the lender will pay less in fees, regardless of their credit scores or down payment sizes.
It's worth noting that even if a borrower has an excellent credit score, they may still be charged LLPA’s if they have a low down payment or a high LTV. This is because the higher the LTV, the more significant the risk of the loan. Therefore, borrowers who put down a larger down payment or have a lower LTV are generally charged lower LLPA's.
Similarly, the type of property being purchased can also affect LLPA’s. For example, investment properties or properties located in areas with a high risk of natural disasters may be subject to higher fees. This is because these properties pose a higher risk to the lender.
It's important to note that LLPA’s are not the same as mortgage insurance. Mortgage insurance is an insurance policy that protects the lender in the event that the borrower defaults on the loan. Mortgage insurance is typically required for borrowers who have a down payment of less than 20%. The cost of mortgage insurance is also affected by the borrower's credit score, down payment size, and LTV.
LLPA’s, on the other hand, are fees that are added to the interest rate or charged as a separate fee. They are not insurance policies and do not provide any protection to the lender in the event of default. Instead, they are used to compensate the lender for the risk they assume in providing the loan.
So, how do LLPA’s affect the cost of borrowing? Let's look at an example, 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%. 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.
The effective penalty for having a credit score under 680 is now smaller than it was. It still costs more to have a lower score. For instance, if you have a score of 659 and are borrowing 75% of the home's value, you'll pay a fee equal to 1.5% of the loan balance whereas you'd pay no fee if you had a 780+ credit score. But before these changes, you would have paid a whopping 2.75% fee. On a hypothetical $300K loan, that's a difference of $3,750 in closing costs.
It's also worth noting that LLPA’s can vary between lenders. Therefore, it's essential to shop around and compare offers from multiple lenders to ensure that you're getting the best possible deal.
It's important to note that the changes to the LLPA’s will only impact loans that are backed by Fannie Mae and Freddie Mac. These two entities are responsible for backing a large percentage of the mortgages in the United States, but not all mortgages are backed by them.
The changes to the LLPA’s are part of broader efforts to reform the mortgage industry. The LLPA changes may actually make it easier for some borrowers to qualify for a mortgage. By accurately pricing loans based on risk, lenders may be more willing to lend to borrowers who were previously deemed to be too high of a risk.
If you're shopping for a mortgage, it's important to understand whether the loan is backed by Fannie Mae and Freddie Mac, and whether the new LLPA’s will impact the cost of the loan.