Government to Punish Good Credit ~ by Andrew Alpaugh
If you are planning to buy a home this year and you have a good credit score, you might be in for a rude shock. A new rule from the Federal Housing Finance Agency (FHFA) that will take effect on May 1 will make you pay more for your mortgage than someone with a lower credit score and less money for a down payment.
The rule is part of a plan by the Biden administration to make housing more affordable and accessible for low-income and minority borrowers. The FHFA oversees Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy and guarantee most of the mortgages in the country. The FHFA has decided to change the way it charges lenders for guaranteeing loans, based on a new risk-based pricing model.
According to this model, lenders will pay lower fees for loans that are considered less risky, such as those with lower loan-to-value ratios, higher credit scores, and shorter terms. Conversely, lenders will pay higher fees for loans that are considered more risky, such as those with higher loan-to-value ratios, lower credit scores, and longer terms.
The FHFA claims that this change will benefit borrowers by reducing the average guarantee fee by 0.02 percentage points, saving them about $200 over the life of a typical 30-year loan. However, this average masks the fact that some borrowers will pay much more than others, depending on their risk profile.
For example, according to an analysis by The Washington Times, a borrower with a credit score of 680 or above and a 20% down payment would pay about $40 more per month on a $400,000 mortgage under the new rule than under the current one. On the other hand, a borrower with a credit score of 620 or below and a 3% down payment would pay about $15 less per month on the same mortgage.
This means that borrowers with good credit and large down payments will effectively subsidize borrowers with poor credit and small down payments. This is unfair and illogical, as it penalizes responsible borrowers who have worked hard to maintain their creditworthiness and save money for their home purchase.
Moreover, this rule could have negative consequences for the housing market and the economy as a whole. By making mortgages cheaper for high-risk borrowers, it could encourage them to take on more debt than they can afford, increasing the likelihood of defaults and foreclosures. This could destabilize the housing market and undermine the financial health of Fannie Mae and Freddie Mac, which are still recovering from the 2008 crisis.
By making mortgages more expensive for low-risk borrowers, it could discourage them from buying homes or refinancing their existing loans, reducing the demand and supply of housing. This could slow down the housing recovery and dampen economic growth.
The new rule also goes against the principle of risk-based pricing, which is widely used in the financial industry to align prices with risks. Risk-based pricing ensures that borrowers pay interest rates and fees that reflect their probability of defaulting on their loans. This way, lenders can cover their costs and losses, while borrowers can access credit according to their needs and abilities.
Risk-based pricing also provides incentives for borrowers to improve their credit scores and save more money for their down payments, which can benefit them in the long run. By contrast, the new rule distorts these incentives and creates moral hazard, as it rewards risky behavior and punishes prudent behavior.
The new rule is also likely to face legal challenges, as it could violate the Equal Credit Opportunity Act (ECOA), which prohibits discrimination in credit transactions based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance. The new rule could be seen as discriminating against borrowers with good credit scores, who tend to be white or Asian, while favoring borrowers with poor credit scores, who tend to be black or Hispanic.
The FHFA should reconsider its decision and revise its pricing model to reflect the true risks of different loans. It should also explore other ways to promote affordable housing without hurting homebuyers with good credit. For example, it could expand its affordable lending programs, such as HomeReady and Home Possible, which offer low down payment options and flexible underwriting criteria for low-income and minority borrowers.
The FHFA should also work with Congress to reform Fannie Mae and Freddie Mac's structure and governance, which have been under conservatorship since 2008. This could improve their accountability and transparency, as well as reduce their systemic risk.
The rule is part of a plan by the Biden administration to make housing more affordable and accessible for low-income and minority borrowers. The FHFA oversees Fannie Mae and Freddie Mac, the two government-sponsored enterprises that buy and guarantee most of the mortgages in the country. The FHFA has decided to change the way it charges lenders for guaranteeing loans, based on a new risk-based pricing model.
According to this model, lenders will pay lower fees for loans that are considered less risky, such as those with lower loan-to-value ratios, higher credit scores, and shorter terms. Conversely, lenders will pay higher fees for loans that are considered more risky, such as those with higher loan-to-value ratios, lower credit scores, and longer terms.
The FHFA claims that this change will benefit borrowers by reducing the average guarantee fee by 0.02 percentage points, saving them about $200 over the life of a typical 30-year loan. However, this average masks the fact that some borrowers will pay much more than others, depending on their risk profile.
For example, according to an analysis by The Washington Times, a borrower with a credit score of 680 or above and a 20% down payment would pay about $40 more per month on a $400,000 mortgage under the new rule than under the current one. On the other hand, a borrower with a credit score of 620 or below and a 3% down payment would pay about $15 less per month on the same mortgage.
This means that borrowers with good credit and large down payments will effectively subsidize borrowers with poor credit and small down payments. This is unfair and illogical, as it penalizes responsible borrowers who have worked hard to maintain their creditworthiness and save money for their home purchase.
Moreover, this rule could have negative consequences for the housing market and the economy as a whole. By making mortgages cheaper for high-risk borrowers, it could encourage them to take on more debt than they can afford, increasing the likelihood of defaults and foreclosures. This could destabilize the housing market and undermine the financial health of Fannie Mae and Freddie Mac, which are still recovering from the 2008 crisis.
By making mortgages more expensive for low-risk borrowers, it could discourage them from buying homes or refinancing their existing loans, reducing the demand and supply of housing. This could slow down the housing recovery and dampen economic growth.
The new rule also goes against the principle of risk-based pricing, which is widely used in the financial industry to align prices with risks. Risk-based pricing ensures that borrowers pay interest rates and fees that reflect their probability of defaulting on their loans. This way, lenders can cover their costs and losses, while borrowers can access credit according to their needs and abilities.
Risk-based pricing also provides incentives for borrowers to improve their credit scores and save more money for their down payments, which can benefit them in the long run. By contrast, the new rule distorts these incentives and creates moral hazard, as it rewards risky behavior and punishes prudent behavior.
The new rule is also likely to face legal challenges, as it could violate the Equal Credit Opportunity Act (ECOA), which prohibits discrimination in credit transactions based on race, color, religion, national origin, sex, marital status, age, or receipt of public assistance. The new rule could be seen as discriminating against borrowers with good credit scores, who tend to be white or Asian, while favoring borrowers with poor credit scores, who tend to be black or Hispanic.
The FHFA should reconsider its decision and revise its pricing model to reflect the true risks of different loans. It should also explore other ways to promote affordable housing without hurting homebuyers with good credit. For example, it could expand its affordable lending programs, such as HomeReady and Home Possible, which offer low down payment options and flexible underwriting criteria for low-income and minority borrowers.
The FHFA should also work with Congress to reform Fannie Mae and Freddie Mac's structure and governance, which have been under conservatorship since 2008. This could improve their accountability and transparency, as well as reduce their systemic risk.
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