Socialized Chaos In Housing

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Recently the Biden administration announced that effective May 1, loan applicants with good credit scores will pay higher mortgage fees and subsidize applicants with poor credit scores to create “equitable” opportunities for home ownership.

This will sow chaos and confusion in an industry already beset with falling sales due to higher mortgage rates, a shortage of housing, and sellers not wanting to sell at lower rates.

As an example, based on the Freddie Mac table (see Exhibit 19), a homebuyer with a 640 credit score who makes a 20% down payment (and thus 80% loan) would see their fee drop from 3% to 2.25%. A homebuyer with a higher 740 credit score who is also making a similar 20% down payment would see their fee rise from 0.5% to 0.875%.

Note that the actual dollar value of the higher credit score buyer is still lower than the lower credit score buyer, but the percentages have changed. The higher credit score buyer now pays higher at 0.875% while the lower credit score buyer pays lower at 2.25%.

“This confusing approach won’t work and more importantly couldn’t come at a worse time for an industry struggling to get back on its feet after these past 12 months,” said former Obama Federal Housing Administration commissioner David Stevens.

This comes at a very bad time as the real estate market has struggled from the massive Federal Reserve interest rate increase these past few months. Under the new rules, home buyers with lower credit ratings who can only afford a small down payment would qualify for better mortgage rates than was normally available to them.

A Shortage Of Housing

The US is short by around 6.5M housing units as of March 2023. Clearly a lot of families want to shift from renting to owning their own home, but housing supply is low, and existing sellers don’t want to sell below previous market prices.

If you prioritize those whose credit scores are low, the percentage of foreclosures due to an inability to pay may also statistically increase, especially given the expected hard times ahead.

Given that on average home mortgages now have risen from around 3% before the Fed rate hikes, to around 6% now, clearly taking on a mortgage now will be heavier on a buyer’s budget. Many may not complete the journey.

Purely from a probability perspective, between someone whose credit score is higher than another, who do you think is statistically more likely to complete the payments spread over several years?

We’ve seen this before. Prior to the 2008 subprime mortgage crisis, the seeds were set. Everyone who wanted to buy a house, never mind if they couldn’t really afford the monthly payments, were given No Income, No Job and Assets (NINJA) loans.

These subprime mortgages were stacked atop each other to generate cash flow for Wall Street. Because of that “noble” desire to give everyone the benefit of home ownership, the global economy almost crashed.

These incentives contradict our perception of what is normal. It’s as if we are rewarding students for arriving late in class and not turning in homework. Imagine what that would do to our school system. People who save for a larger down payment and work hard to maintain a high credit score ought to be given more incentives, and not be penalized. 

Robbing Peter To Pay Paul

What the Biden administration wants to do is to penalize hard working Americans so that they can help the poorer homebuyers afford a home. Sounds noble right? Not if you implement it in this haphazard way. 

The better approach would be to cut mortgage rates across the board evenly so that it benefits all homebuyers equally in terms of percentage. There should be none of this “higher for me, lower for you” strategy.

This scheme of robbing Peter to pay Paul isn’t a level playing field. The incentives are a contradiction of what should normally happen. Those who work hard to maintain a credit score ought to enjoy the benefits of that. Not the other way around. To really fix this, the Fed should already put a stop to rate hikes.

If Biden really wants to help new homebuyers and the housing industry, it should rein in the Fed from further hiking rates to help people equally. It’s the high mortgage rate that’s the problem but treating people unequally with different rate increases and decreases will just create confusion and chaos.