Are Borrowers with high FICO (Credit) Scores going to start paying higher rates than Borrowers with low FICO (Credit Scores)? The answer is no, but also yes. Allow me to explain.
Understanding "Pricing"
There are 2 different ways that every Borrower pays when they obtain a mortgage, which are as follows:
- Up-Front Costs (aka Non-Recurring Closing Costs, aka NRCC's) - these are the 1-time costs a Borrower pays. If I asked any Borrower whether they preferred to pay "high costs" or "low costs" I think you can imagine the answer.
- Interest Rate (aka the "ongoing costs" of borrowing money) - not only do interest rates impact the principal + interest portion of a monthly payment, they also determine the amount of finance charges paid overall during the life of the loan. If I asked any Borrower whether they preferred to pay a "high interest rate" or "low interest rate", I think you can imagine the answer.
Here is the issue folks...you do not get the lowest cost and the lowest rate simultaneously. Think of a see-saw or a teeter-totter, when one goes up, the other goes down (and vice versa).
The summary statement here is "the more you pay in costs, the less you pay in rate" (this refers to paying points to buy down the interest rate below market) and conversely, "the more you pay in rate, the less you pay in costs" (this refers to generating a "lender credit" and applying it towards some/all of the NRCC's in exchange for accepting a higher than market interest rate).
The combination of these 2 different ways a Borrower pays is called PRICING. Therefore, as a Consumer, if you only know the rate, but not the costs (or if you only know the costs, but not the rate), you are not making an informed decision. Now think for a moment about every mortgage advertisement you hear and/or see. They will almost always tout EITHER low rate OR low costs, but not typically BOTH at the same time.
In order to make an informed decision, you need to know the PRICING (which encompasses BOTH the costs AND the rate).
Understanding Loan Level Pricing Adjustments (LLPA's)
LLPA's aka "Pricing Adjustments" are not your friend...they typically worsen the pricing quote once they are applied. There are LLPA's for different qualifying characteristics including (but not limited to):
- FICO (Credit) scores
- Loan-to-Value (LTV) which measures the equity between the loan amount and the property value
- Occupancy Type (Owner Occupied aka Primary Residence, Second Home and Non-Owner Occupied aka Investment Property)
- Type of Property (Condominium, 2-4 Units, Manufactured Home)
- Debt-to-Income (DTI) Ratio - the newest LLPA about to hit the market that measures cash flow. DTI's over 40% will now be priced worse effective 5/1/23.
- Loan Purpose (Purchase, Rate/Term Refinance, Cash-Out Refinance)
- Loan Amount (many counties have both “Conforming” and “High Balance Conforming” categories susceptible to LLPA’s)
Examples of CURRENT LLPA's (as of the date of this article) are as follows:
Example:
In referencing the above chart, let's say we have 2 Borrowers purchasing identical Owner-Occupied (O/O) Single-Family-Residence (SFR) homes on the same day for $500,000. Each are putting 15% ($75,000) as their down payment, and are thus each borrowing the remaining 85% ($425,000) in the form of a mortgage. We refer to this structure as 85% Loan-to-Value (also known as LTV).
Let's say Borrower #1 has a 740 FICO (Credit) Score. Per the yellow highlighted area corresponding to both the 740+ FICO and the 80.01 - 85.00% LTV grid, this Borrower would need to pay a 0.250 pricing adjustment.
Let's say the going BASE PRICING had an interest rate of 6.000% available at a cost of 0 points. When we apply the pricing adjustment of 0.250, the interest rate does NOT go from 6.000% to 6.250%, but instead the rate stays at 6.000%, but the cost/points goes from 0 to 0.250.
If our loan amount is $425,000, we compute the 0.250 costs as follows: $425,000 x .0025 = $1,062.50. Thus in this example, Borrower #1 will pay 6.000% with 0.250 points (aka $1,062.50 in extra costs).
Now despite the fact that Borrower #2 is paying the same price on the same day for an identical property, this Borrower has a FICO score of 659. When we find the corresponding pricing adjustment for this borrower on the chart above (640-659 FICO, 80.01 - 85.00 LTV), the pricing adjustment is 3.250%. Using the same computation method as Borrower #1, the math is as follows: $425,000 x .0325 = $13,812.50 for the same interest rate of 6.000%!
Same interest rate, but Borrower #2 is paying an additional cost of $12,750.00!
In most cases, the Loan Officer would need to adjust the interest rate higher to prevent the Borrower from needing to pay the additional $12,750.00 in costs. Either way, the lower FICO Borrower is paying more for their PRICING than the higher FICO Borrower due to the pricing adjustments highlighted above.
The Newest Controversy - Changes to LLPA's (effective 5/1/23)
Per above, effective 5/1/23, there are new pricing adjustments targeted for implementation. If we use the same example as above, the math is now as follows:
- Borrower #1 (740 FICO) - now has an adjustment of 1.000, which takes the costs from $1062.50 (0.250) to $4250.00 (1.000). Due to this 5/1/23 change, the HIGH FICO Borrower pays an extra $3,187.50 due solely to the new LLPA and their HIGH FICO!
- Borrower #2 (659 FICO) - now has an adjustment of 2.500%, which takes the costs from the original $13,812.50 (3.250) down to $10,625.00 (2.500). Due to this 5/1/23 change, the LOW FICO Borrower now pays $3187.50 LESS due solely to the new LLPA and their LOW FICO!
Is the Government causing HIGH FICO Borrowers to subsidize the costs of LOW FICO Borrowers? A good case can be made to support that narrative! Feel free to look at different apples-to-apples comparisons between the 2 charts above.
Let’s make sure to get our messaging correctly (especially via the soundbites on social media). Higher FICO Borrowers are still paying less in overall PRICING than low FICO Borrowers. With that in mind, despite the fact that HIGH FICO Borrowers are still paying less, the 5/1/23 changes will make the HIGH FICO Borrowers pay more than they are currently paying, while enabling LOW FICO Borrowers to pay less than what they are currently paying. These proposed changes are at the heart of the controversy.
Additional LLPA's Which Do NOT Benefit the Borrowers
But wait, there's more! Per above, you can see additional pricing adjustments, including a brand new one for Debt to Income (DTI) Ratios over 40%. As many Borrowers have DTI Ratios over 40%, this new pricing adjustment will be another example of the new LLPA's NOT benefiting the Consumer!
Summary of Changes
Above is a heat map to help you determine the impacts of these changes at a glance. The greener the highlights, the BETTER the LLPA's are changing. The more red/orange, the WORSE the LLPA changes. Notice the focus of the green positioned at the lower FICO scores and higher LTV’s (aka lower down payment percentages).
How YOU Can Take Action!
CLICK HERE to submit your vote to prevent these LLPA's from taking effect as they are stated above! If you make your voice heard, we may have a shot at overturning these atrocious proposed changes. LLPA's are supposed to be associated with risk. Are we now punishing HIGH FICO Borrowers (who by nature are less risky in that particular category of measurement) by making them pay higher pricing?
Before you take the stance of these changes punishing the “deserving upper class” you’ll want to realize that the upper class typically has Jumbo (aka Non-Conforming) loans which are NOT impacted by these changes. That said, the “middle class” ends up getting hammered by these changes.
Final Thought - CONSUMER WARNING!
A high percentage of mortgage commercials you view and/or hear via various medias DO NOT (I repeat DO NOT) compute PRICING ADJUSTMENTS into their quotes! Therefore, if you are comparing a CUSTOMIZED PRICING QUOTE (from a presumably ethical & reputation-based Loan Officer) with a 30 second commercial you heard on the radio (with a fast-talking auctioneer-style voice at the end of the commercial rattling off "disclaimers" that you cannot decipher), you are NOT making an informed decision as a Consumer.
Can we please stop punishing ethical Loan Officers who are customizing your quote in favor of blast advertising gimmicks intended to lure you? Let's be better folks, thanks for indulging my rant!
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