What The New Biden Rule Means For Home Buyers With Bad Credit

To offer more affordable housing solutions for Americans with poor credit, the Biden Administration’s Federal Housing Finance Agency (FHFA) will introduce new rules for loan-level price adjustments (LLPAs) that Fannie Mae and Freddie Mac can use for mortgage rates. But how do these LLPAs work, and what does it mean for homebuyers with bad credit scores?

How LLPAs work

LLPAs are adjustments made to mortgages guaranteed by Freddie Mac and Fannie Mae. These adjustments are often based on risk assessments the agencies use for mortgage applicants and can include, but are not limited to:

• credit scores (not your credit rating. Here are the main differences between credit rating and credit score)
• loan-to-value (LTV) ratio
• type of mortgage (based on occupancy type, etc.)

Lenders often convert LLPAs into the interest rate charged on a mortgage which is why those with higher credit scores tend to have more competitive mortgage rates, as their risk assessments often rank them as low risk.

What changes are coming to LLPAs

Effective May 1, 2023, loans purchased on or after this date will be subject to a new LLPA Matrix. This new Matrix will factor in further details, such as an applicant’s debt-to-income (DTI) ratio.

This new inclusion of DTI ratios could benefit those with good credit scores, as applicants with a DTI of less than 40% should see a decrease in their LLPAs, particularly in their cumulative upfront fees.

However, those with a credit score of 680 or lower and a DTI greater than 40% may get hit with a fee increase. Experian reported that at least 35% of the population could be impacted and see an average increase of approximately 0.36%. However, an additional factor in determining this increase is LTV rates.

LTV rates for loans that are cash-out refinances or high-balance loans will be the most affected by this new change.

For those with an LTV greater than 75% and:

• a DTI of 40%+
• VantageScore under 680

It’s almost guaranteed that they’ll see a 0.36% increase in LLPAs. Those who don’t meet all of these factors may see either a decrease or no change at all.

How to ensure you won’t get hit with new LLPA fees

The easiest way to ensure your new mortgage won’t include a bump in LLPA fees is to improve your credit score before applying. It’s absolutely vital that you work to get your credit score over 680 and improve your DTI before house hunting so that you’ll get the most competitive interest rates possible.

Several factors determine your credit score, each with its own weight for how they affect your score:

Number of on-time payments – The number of late payments on your credit report is the most significant factor, accounting for 35% of your total score. If you have any late payments on your report, you should focus on getting things back on track and making the minimum payments on time, every time.

Credit utilization ratio –  The amount of your balance you carry over every month divided by your total available credit is your Credit Utilization Ratio. This accounts for 30% of your FICO score. To get a competitive rate, you’ll want a utilization of 20% or lower, but the highest scores use 10% or less of their credit.

Average age of credit – Lenders want to work with those who have long histories of utilizing credit responsibly. “Good” metrics for this tend to be an average age of 5+ years. But if you don’t have a long history, don’t worry; this only accounts for 15% of your score.

Mix of credit – The best scores have a mix of loans and credit cards on their report. This factor isn’t heavily weighted and only accounts for 10% of your score, so don’t worry if you’ve only got a few student loans or only credit cards showing.

Hard inquiries – Any time your report is pulled for a credit application, a hard inquiry is added. Note that there’s a difference between hard vs. soft credit checks, so don’t worry if you use apps or websites that check your credit daily. Hard inquiries should be less than three per year, but this only accounts for 10% of your total score.

The bottom line

New changes to LLPAs could mean you’re paying more for a mortgage than before, so getting your credit score as high as possible before applying is essential. An average increase of 0.36% might not seem like a lot, but every dollar counts in today’s competitive real estate market.