Americans With Good Credit Penalized, Bad Credit Is Rewarded

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
May 9, 2023

Americans With Good Credit Penalized, Bad Credit Is Rewarded

IN THIS ISSUE:

1. Biden’s Plan To Penalize Responsible Homebuyers

2. Much Higher Loan Level Pricing Adjustment Fees

3. Unintended Consequences of Biden Homeownership Policies

4. It’s All About Social Justice, Whether It Works Or Not

Biden’s Plan To Penalize Responsible Homebuyers

In his effort to impart more “social justice” into the homeownership market, President Biden has implemented a new policy which penalizes home buyers with good credit and rewards those with bad or less than good credit. This makes no sense, of course.

The overall impact of Mr. Biden’s latest scheme is to increase the cost of credit for those with good credit and lower the cost of credit for those with bad credit. Here’s how it’s supposed to work.

The Federal Housing Finance Agency just announced it will change the loan-level pricing adjustment fee on homebuyers. A loan-level pricing adjustment (LLPA) fee is a fee that is charged to mortgage borrowers who use a conventional mortgage, and the fee is based on the borrower’s level of risk.

The LLPA fee can vary depending on factors such as the borrower’s loan-to-value (LTV) ratio, credit score, type of occupancy and the number of units in the property. Typically, borrowers pay LLPAs in the form of higher mortgage interest rates and or fees.

The Federal Housing Finance Agency recently announced it will hike the loan-level pricing adjustment fee on homebuyers with high credit scores and redistribute those funds to borrowers with low credit scores.

That’s not an insignificant change.

Much Higher Loan Level Pricing Adjustment Fees

Under the new loan-level pricing adjustment matrix, a borrower with a 740 FICO score and a down payment around 20% will pay a 1% loan-level pricing adjustment fee. That’s quadruple the prior risk assessment of 0.25%.

At the same time, the loan-level pricing adjustment fee for many borrowers with bad credit will be slashed by half or more. A borrower with an under-640 FICO score and borrowing 97% of the purchase price will see his or her fee slashed to 1.75% from 3.50%, a $9,270 savings on that same home.

The high credit-score borrower purchasing a median-priced $546,077 home in Riverside, California (one of the more affordable places in the state), will pay an additional $3,276 in loan-level pricing adjustment fees. That amounts to $20.71 in extra monthly costs if financed at 6.5% over the course of a 30-year mortgage.

That represents more than just a forfeited dinner out each month. If a young homeowner in her 30s could invest that additional monthly mortgage expense into a retirement account at 8% annual returns, this additional monthly payment would grow to nearly $31,000 upon retirement.

The overall impact of the scheme is to increase the cost of credit for those with good credit and lower the cost of credit for those with bad credit.

Unintended Consequences of Biden Homeownership Policies

In some instances, this redistribution of credit may even be regressive. Millions of Americans with modest incomes possess better credit access than those with higher incomes. FICO scores are not dependent on one’s income, but rather, on one’s utilization of credit and track record of timely payments.

Forcing high credit-score families to subsidize those with subpar credit will perversely result in some less-well-off (but financially responsible) families paying for the imprudent decisions of their higher-income (but financially irresponsible) neighbors.

In some instances, the slightly higher debt-to-income (DTI) ratios resulting from adding this fee into the requested mortgage will exceed DTI limitations, artificially shrinking the housing purchase options.

In addition to driving up borrowing costs for many responsible families who have exercised prudent credit management and savings discipline, expanding credit to those with riskier borrowing profiles may make housing even less affordable, especially in the lower-priced housing segment if demand increases as a result.

That segment of the market has already inflated by 46% in just the past four years. Combined with soaring interest rates, mortgage payments on median-priced homes have skyrocketed from under $1,500 just two years ago to nearly $2,700 today.

Of course, affordable housing was never the goal of this proposal, but rather a vague notion of “equity.” In the words of Federal Housing Finance Agency Director Sandra L. Thompson, “[This change is] another step to ensure … equitable and sustainable access to homeownership.”

Heightened unaffordability is a direct side effect of this warped credit scheme dreamt up by those who think this nation is fundamentally unjust.

It’s All About Social Justice, Whether It Works Or Not

The essence of this government-sponsored scheme is equity rather than on justice, fairness, or efficiency. For today’s revolutionaries, fundamental societal inequity is to blame for the disparity of access to credit, rather than the choices made by individuals in matters related to financial health.

In the eyes of the radical Left, those with subpar credit scores are often deemed victims trapped into making the decisions leading to those lower FICO scores. Meanwhile, those with the higher scores are more apt to be privileged beneficiaries of a system rigged in their favor, so they say.

What better way then to redistribute wealth than by redistributing credit from those with high credit scores to those with low ones?

If politicians truly wanted to expand credit access for a greater portion of the population, the focus would be on teaching consumer finance skills to high school and college students to equip everyone with the knowledge to accumulate wealth and attain credit.

And if politicians truly wanted to address the housing affordability bubble, they would stop funneling trillions of dollars to the housing market through subsidies, government-guaranteed mortgages and Federal Reserve mortgage-backed securities purchases—policies that have created the most unaffordable housing in history.

And speaking of backward policy, how about a rule adding a $50 monthly premium increase on those with flawless driving records and reducing the premiums for those with multiple speeding tickets and perhaps a DUI?

Not only would this penalize good behavior, it would enable those with reckless habits to upgrade their rides.

Of course, we see the unfairness of punishing responsible driving and rewarding the reckless. But this woke notion of distributing benefits—whether credit, contracts, jobs, or college admissions—based on “equity” rather than merit is spreading.

Of course, low credit scores are oftentimes due to unfortunate circumstances, rather than poor choices. Thankfully, we live in a nation where individuals can rebuild their credit, whether those rough stretches were due to their own mistakes or the misfortunate that can beset anyone through no fault of their own.

Even for those just two years out of bankruptcy, high loan-to-value mortgages are available. We can support second chances without demanding everyone else subsidize this added risk. This latest credit scheme isn’t fair or just. But it is “social justice.”

You should rightfully bristle at the notion of the government penalizing prudent financial behavior in its attempt to subsidize the imprudent decisions of others. But this is just another step in the woke agenda for the financial sector, where access to credit depends less and less on your ability to generate the required payments to the lender and far more on your membership in a politically favored class.

Already, some banks restrict credit to disdained businesses, such as firearms dealers and fossil fuel companies. Sadly, this woke mortgage risk repricing is emblematic of our Brave New World.

It amazes me how the liberal media has embraced the “woke” movement when its clear it makes no sense and most Americans who are aware oppose it. Yet here we are and the Left is pushing a liberal agenda to make things more equitable regardless whether such policies will actually produce the desired outcomes. What else is new?

Fortunately, for most investors, we don’t need to make any significant changes to our investment strategies. The Fed is widely expected to pause its interest rate hikes going forward, and stocks have a history of moving higher after these rate tightening cycles. I don’t expect anything different this time around.

The forecasting crowd continues to predict a recession just ahead, and we may well get it. Most forecasters do not believe it will be a severe recession but a rather mild one that doesn’t last too long. I don’t disagree.

What I will continue to point out, however, is that something must happen to slow down consumer spending before we can have the next recession. Retail sales fell 1% in March but are still up 2.9% for the year. We will need to see more weakness before a recession unfolds.

Maybe that is what’s coming. We’ll see soon enough.

Very best regards,

Gary D. Halbert

SPECIAL ARTICLES

Biden’s Plan to Penalize Responsible Home Buyers

A Way Out of the Debt Ceiling Dilemma

Biden-McCarthy Showdown Over National Debt

Gary's Between the Lines column:
Another Debt Ceiling Showdown – They Just Never Learn