Understanding Loan-Level Pricing Adjustments (LLPA): A Complete Guide
Tracey Morgan once said, “Bad news travels at the speed of light; good news travels like molasses.”
It seems like just overnight the internet was overflowing with news regarding a “new” unfair tax on mortgage borrowers with higher credit scores and that those with lower credit scores could get a better deal. What is this all about? Well before you stop paying your bills on time and end up with a poor credit score, we’re here to explain!
Let’s clear the air. You will not get a better deal on a mortgage rate if your credit score is lower. This news all has to do with changes to Loan Level Price Adjustments (LLPAs) imposed by Fannie Mae and Freddie Mac (the “Agencies”), the two entities that guaranty a vast majority of new mortgages.
What is Loan-Level Pricing Adjustments and How Do They Work?
LLPAs known as Loan-Level Pricing Adjustments isn’t something new. In fact, they were introduced into conventional mortgage lending in April 2008, and they remain in effect today. LLPAs are fees the government mortgage entities set relative to the nature and potential risk in different loan scenarios. They are literally, adjustments to the “price” of a loan. Loan prices are what determine a borrower’s interest rate. More risk means higher costs, and these costs are passed to borrowers in the form of higher rates or points. LLPAs can change a borrower’s rate by 100 basis points (1.00%) or more.
This fee is based on the borrower’s level of risk and can vary depending on factors such as:
- Borrower’s loan-to-value ratio (LTV)
- Credit score
- Number of units the property has
- The type of mortgage also comes into play. For instance, adjustable-rate-mortgages (ARMs) which have interest-only payments, may have higher LLPAs
Loan-Level Pricing Adjustments have changed several times over the years and a substantial change was announced in January 2023 by the Federal Housing Finance Agency. Some changes were positive, and some were negative. These changes take effect with any loans delivered to the two Government Sponsored Enterprises (GSEs) on or after May 1st, 2023.
Breaking Down Some Key Mortgage Terms
As mentioned above, LLPAs are calculated using several factors. Credit score is one. Clients with lower credit scores are considered riskier borrowers and could be charged with higher LLPAs. On the flip side, those with higher credit scores will be charged less LLPAs. Sometimes LLPAs can be avoided all together. Speak with your loan officer for more information.
Another term we mentioned earlier is Loan-To-Value Ratio (LTV). LTV is also used to determine LLPAs. It is the amount of mortgage loan divided by the appraised value of the property. The higher the LTV ratio, the higher the LLPAs are going to be.
What Loans Are Affected?
Keep in mind, this new rule was set to help improve housing affordability here in the United States. Loans affected include conventional mortgages and refinance loans purchased by Fannie Mae and Freddie Mac. FHA, VA, USDA, and HUD Section 184 mortgages have been excluded.
What does this new pricing shift mean for borrowers? Although having a credit score under 680 is now smaller than it was, it will still cost more to have a lower score. Take for example, someone who has a credit score of 659 and is borrowing 75% of the home’s value, they would pay a fee of 1.5% of the loan balance whereas you’d pay no fee if you had a credit score of 780+. Before these changes, there would have been a 2.75% fee! On a hypothetical $300k loan, that's a difference of $3750 in closing costs. Furthermore, they have also recently introduced new credit score thresholds for LLPA at 760 and 780, whereas previously they only went up to 740.
Now onto borrowers with higher credit scores. They will generally be paying a little more than they were under the previous structure.
The following chart from MBS Live, LLC explains the differences.
- Green and yellow cells show where things have become more affordable than they were.
- Orange and red cells = more expensive.
- All values refer to a percentage of the loan balance charged as an upfront fee.
Not noted on the heat map above is the new charge for Debt-to-Income (DTI) ratio. Mortgage News Daily reports, “This will be controversial in many scenarios as income calculations can be somewhat subjective and debt calculations can be legitimately "tweaked" with some advanced planning and/or debt consolidation. Nonetheless, every loan guaranteed by the agencies has a DTI attached to it. If yours is over 40% and you're borrowing more than 60% of your home's value, you'll be paying more.”
- Update as of May 5, 2023: Members of the mortgage industry stepped in to say the new LLPA would not only lead to confusion and mistrust among borrowers but would also be difficult to implement fairly. First, the agencies postponed implementation. Then, they cancelled it!
Who Will Benefit and Who Will Feel the Effects from the LLPA Changes?
The adjustments mentioned above will not be the same for everyone. It depends on individual financial scenarios and the type of property being financed. They do not make home financing cheaper for those with bad credit and more expensive for those with good credit.
Fannie Mae says its mission is “to facilitate equitable and sustainable access to homeownership and quality, affordable rental housing across America. We continue to address the inequities of the past and are working to reduce the housing gaps that exist for members of underserved communities." And Freddie Mac’s mission states they want to "serve America's homebuyers, homeowners, and renters by providing liquidity, stability, and affordability to the housing market.
If you’re thinking of a purchase or refinance this year, please reach out now to see if the fee changes may impact your scenario. We can weigh the potential costs and benefits of acting before these changes occur.
The team at Greenway Mortgage is here to help when you’re ready.