Signature RM Blog

The price of credit scores just went up. Last month, Fannie Mae implemented risk based pricing. The FHA Modernization Bill has components of risk based pricing. What is "risk based pricing?" In a nut shell it's another tightening of mortgage products. It makes mortgage rates for people with lower credit scores more costly. Higher payments for people with lower credit scores, makes sense to the investment bankers that own the securitizations. Higher risk should yield a higher return.

To the consumer that has a 650 credit score with 10% down payment could cost as much as .375%-.500% in rate on a standard 30 year fixed mortgage, up to .75% for lower than a 620 credit score. These adjustments may be needed but reality is less people will swallow the higher payment.

In order to understand the magnitude of the changes, one should be familiar with how it worked before. Fannie Mae uses an automated underwriting system called Desktop Underwriter/Desktop Originator (DU/DO) to determine risk for potential mortgages. This system uses historical data of millions and millions of prior mortgage borrowers and compares the characteristics with performance of similar files. After analyzing credit, income, assets and collateral it would return the results. Fannie would break the risk levels into 5 categories if closable: Approved, EA-I, EA-II, EA-III, Refer with Caution (EA=expanded approval). These risk levels have tiered pricing adjustments that affect the yield spread premium paid by the lender.

What's the change? DU/DO supposedly has never used credit scores to determine eligibility but analyzes the tradelines that make up the credit report. If the system determined that the loan should be approved, the borrower with the 620 score received the same rate as a 720 score. Conversely a 720 score borrower could receive an EA-I approval which would require a higher rate than a 620 credit score borrower with an Approved. I'm sure I could write an entire blog on how and why the system works the way it does. Without getting too in depth, assets have always made a big difference. If the 620 credit score example has $100,000 in the bank after closing DU/DO may consider that less risky than the 720 score with no assets.

Now lower credit scores will pay higher rates regardless of the approved findings.