Lower rates coming for low down payment buyers with riskier credit scores

Pricing changes come as the FHFA raises upfront fees for second-home loans and high-balance loans.

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | January 30, 2023

Article originally posted in Orange County Register on January 26, 2023.

If you are a marginally credit-qualified homebuyer itching to get on the road to homeownership, hold off until April 1. That’s when mortgage lenders will start rolling out pricing discounts for Fannie Mae and Freddie Mac borrowers who have challengingly low FICO scores.

Homebuyers with middle FICO credit scores between 620-660 and small down payments are going to be the biggest winners.

For example, let’s say you are putting 5% down and have a 620 FICO score. Once the new F&F pricing chart kicks in, it will cost either 1% less in loan points (for example, 1 point or 1% of a $500,000 loan balance is $5,000). Or a borrower can convert the savings into a lower rate, roughly 0.375% lower, instead of fewer points.

More poorly qualified, riskier borrower pricing improvements are being subsidized by a whole host of other conventional mortgage products along with tacking on additional loan level pricing adjustments (industry jargon for pricing adds). In a nutshell, the well-qualified buyer will see their fees increase.

For example, a homebuyer with a 740 middle-FICO score with a 15% down payment, will see 0.75 points more in fees or about a quarter point in rate.

So, what’s really happening?

The Federal Housing Finance Agency, Fan and Fred’s regulator and conservator, on Jan. 19, updated the agencies’ single-family home loan pricing framework, recalculating upfront fees for purchase, refinance and cash-out refinance loans.

“FHFA is eliminating upfront fees for certain first-time homebuyers, low-income borrowers, and underserved communities to promote sustainable and equitable access to affordable housing,” said Director Sandra L. Thompson.

The administration said its pricing changes come as it targets upfront fee increases for second-home loans and high-balance loans first announced in early 2022.

The industry reacted cautiously to the news, hinting the new fee structure could make affordability for some buyers worse.

“Our initial review indicates that the new framework results in a modest net increase in overall pricing, which is a concern given ongoing affordability challenges and the higher interest rate environment,” said Bob Broeksmit, the president and CEO of the Mortgage Bankers Association, in a Jan. 19 press release.

Broeksmit also suggested the FHFA consider more program changes that could expand access and affordability, including raising the area median income threshold for low-down payment products.

“This move would expand eligibility for borrowers who can meet the monthly obligation of a mortgage payment but do not have significant savings to make a large down payment,” he said.

Let’s be real about all of this.

Fannie and Freddie have always subsidized mortgages for residential real estate borrowing with cheaper rates or better terms (compared with other commercially available banks, for example) from their inception. This particular administration is more focused on helping marginally qualified homebuyers. Other administrations have had their own sets of goals. Good, bad, right or wrong.

My hackles, however, are up. This could also be a repeat of the pre-Great Recession days. Fan and Fred in those days were chasing the subprime lenders with their own fast and loose underwriting rules. The predatory lenders got all the headlines for the foreclosures and such, but Fan and Fred were right there too, giving mortgages to questionably qualified borrowers with little skin in the game.

Here’s an eclectic list of extra things for house hunters to consider:

Well-qualified borrowers who think they’ll need a mortgage of some sort in the near term should start shopping now. Lock in a rate before the new price hits take effect.

Even though Fannie and Freddie are creating a path to more affordable homeownership with better pricing for marginally qualified borrowers, all buyers should proceed with caution. Just because you can qualify, it doesn’t mean you should run out and make yourself a homeowner if you are not ready.

“Not ready” includes a lack of discipline when it comes to paying your bills. Or you are worried about losing your job or your source of income as the job market becomes shakier. Or perhaps, for one reason or another, you will be moving away from the area in less than five years.

Fannie averages your three scores. For example, let’s say your scores are 610, 630 and 680, averaging out at 640. Using a 640 FICO means your pricing is better by 0.375 in point cost or better by 0.125% compared with using a 530 middle-FICO score. The credit buckets are 620-639, 640-659, etc.

One additional credit score footnote is the top credit bucket was 740 or above for Fan and Fred. With the new rules, there are also new buckets of 740-759, 760-779 and 780 or above. In some cases, your pricing will be better with these super-duper, new FICO buckets.

Federal Housing Administration mortgages may still provide for a lower overall mortgage payment for those riskier borrowers (620-640 middle FICO scores) who can also qualify for F & F conventional financing. The minimum FHA down payment is 3.5% of the sales price whereas conventional is 5% down but sometimes 3% down if you qualify for the programs called Home Ready or Home Possible.

Either way, buyers pay monthly mortgage insurance for low-down payment conventional financing (less than 20% down) and FHA financing.

But as the looming recession will likely trigger lower mortgage rates, homebuyers should look hard at going conventional because they could avoid the very expensive upfront FHA mortgage insurance.

For example, assuming a base loan amount of $500,000, the actual FHA balance becomes $508,750 because of the 1.75% upfront mortgage insurance premium or MIP. This is separate and above the monthly FHA mortgage insurance premium. So, borrowers are looking at an initial debt amount of $508,750 vs. $500,000 conventional.

My advice: If your conventional payment is a few hundred more monthly but you’re hoping to soon roll the rate down, then take the higher payment hit upfront in exchange for a reduced loan balance when it’s time to knock that payment down.

Freddie Mac rate news: The 30-year, fixed-rate averaged 6.13%, 2 basis points lower than last week. The 15-year, fixed-rate averaged 5.17%, 11 basis points lower than last week.

The Mortgage Bankers Association reported a 7% mortgage application increase from last week.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $726,200 loan, last year’s payment was $1,134 less than this week’s payment of $4,415.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.25%, a 15-year conventional at 4.625%, a 30-year conventional at 5.5%, a 15-year conventional high balance at 4.875% ($726,201 to $1,089,300), a 30-year high balance conventional at 5.875% and a jumbo 30-year fixed at 6.25%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $726,200 in LA and Orange counties.

Eye catcher loan program of the week: A 30-year VA fixed rate at 5.125% with 1 point cost.

Jeff Lazerson is a mortgage broker. He can be reached at 949-334-2424 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.