The Federal Housing Finance Agency (FHFA) has faced criticism for its latest round of changes to the pricing that Fannie Mae and Freddie Mac charge for their guarantee. Critics claim that FHFA is overcharging those with good credit so that it can undercharge those with bad credit, making homeownership more challenging for one group to make it easier for another. But the criticism is misplaced, conflating two separate, largely unrelated moves on pricing for the government-sponsored enterprises, or GSEs.
Last year, FHFA increased pricing on loans for which there is less justification for deep government support—loans for vacation homes, investor properties, million-dollar homes, and cash-out refinancing. And FHFA has used the increased revenues from those changes to decrease costs for people who genuinely need the help—borrowers with limited wealth or income.
In a separate move, FHFA is also increasing pricing in the GSEs’ core business, not to generate cross-subsidy but to cover the higher capital requirements that went into effect last year. The increases here will raise pricing on the average loan in their core business by about 4 basis points, or $10 a month for someone taking out a $300,000 mortgage. A modest portion of that increase will cover the risk that profits from business lines that warrant less government support fall short of what is needed to cover those that warrant more government support. But the portion of the cross-subsidy these changes cover is small.
Critics have pointed out that the GSEs will be charging some borrowers less if they put down a smaller down payment, claiming that this shows that FHFA will be cross-subsidizing within their core business. (See the GSE Loan-Level Price Adjustment Matrix here). As borrowers who put down less for a down payment typically pose more risk, it suggests that FHFA is making homeownership unnecessarily expensive for some to make it less expensive for others. But this leaves out a critical piece of the story.
Anyone who makes a down payment of less than 20 percent of the value of their home must take out private mortgage insurance to cover the first portion of any loss on the loan. So those who put down less than 20 percent pose less risk to the GSEs and should pay less in fees to the GSEs. The reason the GSEs' pricing peaks at loan-to-value (LTV) ratios of 80.01 to 85.00 percent rather than 75.01 to 80.00 percent is that borrowers can drop their mortgage insurance when the LTV ratio hits 78 percent, leaving the GSEs unprotected after only a couple of years of payments by borrowers with LTV ratios of 80.01 to 85.00 percent.
Borrowers who put down less than 20 percent will still pay more in total fees for their mortgage because they will pay a private mortgage insurance premium in addition to their GSE fees. So if the cost of mortgage insurance is added to the GSEs’ pricing grid, the borrowers’ costs will track their risk as one would expect: those with lower credit scores will pay more than those with higher credit scores, and those with higher LTV ratios will pay more than those with lower LTV ratios.
Despite the recent coverage, then, FHFA is not raising fees on borrowers with good credit to lower them for those with bad credit. It is raising fees on loans there is little reason to discount so that it can better serve those who need the help. While FHFA is also raising fees modestly on the GSEs’ core business, this increase is paying almost entirely for higher capital requirements, not the cross-subsidy.