Welcome to CNBC Select's advice column, Getting Your Money Right, where financial advisor Kristin O'Keeffe Merrick will be answering your pressing money questions. You can read her last installment here on whether to invest in Treasury securities. Have a question you want to ask? Send us a note at AskSelect@nbcuni.com.
Dear Kristin,
I recently had a weird conversation with someone who told me that, under new mortgage lending rules, I can get a better deal on my mortgage if I have a lower credit score. This seems to defy logic. Can you clarify what this all means?
Signed,
Confused in California
I recently received a few panicked text messages in my high school group text. "Kristin, what is this about? Should I try to ruin my credit score on purpose now?" Uh oh, I thought. This can't be good. I dove into the attached article sent by my friend and read that people with higher credit scores would have to start paying more for their mortgages than those with lower scores.
Before I break down why this article's information is misleading at best, I'll give you a simplified version of what you need to know. People with higher credit scores will still pay less for their mortgages than people with lower scores — so do not, under any circumstances, stop paying your credit card bills with the hope that you'll get a better deal on your mortgage. Now let's take a look at why this rumor is running wild.
What's really going on
Diving into the details of how the mortgage market works can make even the most patient person break down in tears, but here are the facts driving claims that borrowers with bad credit will pay less for their mortgages than those with high scores.
- The Federal Housing Finance Agency (FHFA) sets guidelines for how mortgages are structured by regulating Fannie Mae and Freddie Mac (the government-sponsored enterprises that guarantee most new mortgages).
- In January of this year, the FHFA announced changes to a set of fees known as loan-level price adjustment (LLPA). These are upfront fees based on the risk profile of the individual borrower, which is determined by the borrower's credit score, loan-to-value ratio, down payment amount, and other factors.
- These fee changes, which took effect on May 1, were meant in part to make housing more affordable for borrowers "limited by income or wealth," according to an FHFA letter released in April.
- In some cases, this may mean a borrower with a low credit score may now pay less in LLPA fees than a borrower with the same low credit score would have paid before the changes were implemented. Likewise, a borrower with a high credit score may now pay more in fees than they would before the recent changes to the fee structure. Still, under the new rules, some borrowers with high credit scores will actually pay less in fees than before.
However, there is no scenario where having a lower credit score causes you to pay a lower fee than someone with a higher credit score, all other factors being equal. If, for example, you have a credit score of 640, you will have a higher LLPA fee than if your credit score was 740.
Also remember that the higher your credit score, the more likely you are to get a lower interest rate, which is where you'll save the most money on a mortgage in the long term.
Before applying for a mortgage, it's crucial to know where your credit stands. The best credit monitoring services offer triple-bureau protection, looking at your information across all three credit bureaus.
Experian IdentityWorks℠ Premium monitors all three of your credit reports to make you aware of activity including score changes, new inquiries and accounts opened in your name, changes to your personal information and suspicious activity detected. Plus, you'll regularly receive updates to your FICO® Score.
The best and most accurate way to keep tabs on your industry-specific FICO Score is with FICO Basic, Advanced and Premier credit monitoring services. All plans offer access to 28 versions of your FICO Score, including scores for credit cards, mortgages and auto loans. Plus, you'll receive $1 million identity theft insurance and 24/7 access to U.S.-based identity theft experts who can help restore your identity if your information is compromised.
In the end, Fannie Mae and Freddie Mac have implemented these changes to promote affordable home ownership. Some may agree with these changes while others will most certainly not. That said, don't attempt to lower your credit score for a better deal on a mortgage because that will likely backfire. Also, the next time you read a piece like the one that inspired me to write this, seek out a professional opinion first.
All the best,
Kristin
Kristin O'Keeffe Merrick is a Financial Advisor and money expert at her family-run firm, O'Keeffe Financial Partners, located in Fairfield, NJ.
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