Saturday, August 16, 2008

Winners and Losers As Loan Fees Change

(WP) The two biggest sources of mortgages for American home buyers plan to raise their base fees to counter what they call continuing "adverse conditions" in the real estate market.

At the same time, Fannie Mae and Freddie Mac, which fund more than three-quarters of all new home loans, also plan to selectively reduce fees for certain applicants whose likelihood of default and foreclosure appear to be lower than the companies' previous estimates.

The changes are being driven by what's known as risk-based pricing. Factors such as credit scores, the size of the down payment and the type of loan can push expenses on a new mortgage up or down significantly -- costing or saving a borrower tens of thousands of dollars over the term of the loan.

Here's what's happening: As of Nov. 1 for new mortgages delivered to Fannie Mae, and Nov. 7 for those delivered to Freddie Mac, baseline "adverse market" fees will be doubled, to 0.5 percent -- from $250 per $100,000 borrowed to $500 per $100,000 borrowed. That applies to all home purchasers and refinancers, irrespective of their individual risk characteristics. The higher fees either will be paid up front by borrowers or will be folded into the interest rate on the notes, adding about an eighth of a point.

Although the formal start dates for the higher fees are not until fall, major lenders already are incorporating them into their quotes and rate sheets. Neither company announced the jump in fees to the public but instead sent e-mail bulletins to their lender partners.

On the flip side of the higher baseline costs is a series of risk-based pricing changes keyed to borrowers' scores and down payments. Both companies plan to reduce fees for borrowers with high FICO credit scores -- 720 and up -- who make down payments of less than 15 percent. These borrowers will be quoted credits of one-quarter of a percentage point, amounting to cuts in their fees, at the application stage.

At the same time, borrowers with FICO scores below 720 and down payments of less than 15 percent will be charged quarter-point higher fees upfront. Why? Credit scores never have been more powerful in determining the rates and fees borrowers pay. Even more important, credit-score standards are being ratcheted up dramatically.

During the housing boom years, the dividing line between subprime applicants and borrowers deserving better rate quotes was a 620 FICO. A 700 score was a virtual guarantee of the best quotes available. Fair Isaac Corp.'s FICO scores range from about 300 -- the highest risk -- to 850, the lowest risk. Now, even FICO scores in the upper 600s or above 700 are subject to higher fees in some cases.

For example, if you are applying for a loan destined to be funded by Fannie Mae and you have a 739 FICO score and a down payment of 20 percent to 25 percent, you're likely to be hit with a quarter-point fee increase that you wouldn't have been charged as recently as last month.

You might protest. Since when is a FICO of nearly 740 not deserving of the lowest fees? Fannie's implicit answer through its revised risk-based pricing system: Sorry, but a 739 FICO no longer makes the highest grade when the applicant can't make a 30 percent or 40 percent down payment.

Worse yet, if you've got a FICO score below 720 and don't have at least a 30 percent down payment, you're going to get hit with a half-percentage-point delivery fee upfront.

So why are Fannie Mae and Freddie Mac actually decreasing fess to borrowers with high credit scores who make down payments of less than 15 percent? Isn't that counterintuitive, because default risks rise when down payments are smaller?

Yes, but in Fannie Mae and Freddie Mac's world, all loans with 20 percent or smaller down payments require private mortgage insurance to protect the companies from the deepest losses associated with foreclosures. Now both companies have decided that they can charge a little less on such loans because the insurance lowers their risk of serious loss. That's good news for moderate-income first-time buyers with sterling credit who don't have a lot of cash.

Not coincidentally, both companies are required by Congress to serve such creditworthy buyers, many of whom have lately been turning to the Federal Housing Administration for lower-cost, low-down-payment mortgage deals.

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