Why Good Credit Borrowers Will Soon Pay More for Mortgage Loans

While not written in stone, there is a general rule when it comes to taking out consumer debt, such as a mortgage loan: the better your credit history, the better the loan terms and rates you’ll be offered. However, a new federal rule from the Biden administration will change that in an unprecedented way. 

What the New Rule Does

In recent years, the Federal Housing Finance Administration (FHFA) — the entity responsible for monitoring and oversight of Fannie Mae and Freddie Mac — has made it clear that housing affordability for Americans is a primary goal. The current White House administration seems to be taking that goal to heart, enacting a surprise federal rule that effectively uses home mortgage borrowers with good credit to subsidize borrowers with lower credit scores.

According to the new FHFA federal rule, good credit borrowers will pay more fees than before on their home mortgage loans. At the same time, borrowers with lower credit scores (and lower down payments) will pay notably less, even if they have a lower down payment amount.

The goal of the program is to provide equitable housing solutions for a wider pool of borrowers. In practice, though, it leaves many high FICO homebuyers wondering why years of efforts are being penalized.

The rule is set to go into effect on May 1, 2023, though the FHFA and its Office of Fair Lending Oversight (OFLO) have gotten their share of pushback since news of the rule spread.

How the New Rule Works

According to a new report from the Washington Post, the federal rule will affect buyers by changing each mortgage’s loan-level price adjustment, or LLPA. These adjustments are front-end fees imposed on new mortgage loans according to specific borrower factors, including credit score, debt-to-income ratio (DTI), and down payment amount.

For new mortgage borrowers with a FICO credit score of 680 or higher (a Good rating, according to MyFico), LLPAs will increase substantially when the rule goes into effect. For example, a borrower with a 740 FICO score and an 18% down payment would be subject to an LLPA of 0.25% prior to May 1; after that date, though, this same buyer would be subject to a 1.00% fee instead.

Conversely, a borrower with a credit score of just 615 and a 4% down payment would pay an LLPA fee of 3.5% today. After May 1, that same buyer with that same down payment would only pay a fee of 1.75%

The Old Way of Underwriting Home Mortgage Loans

So, why does credit score matter when buying a home anyway?

Up until now, home mortgage loans have been underwritten with a few borrower specifics in mind. These factors allow a lender to vet a potential buyer and determine A) whether they are likely to repay the loan as promised, B) whether the lender wants to offer a loan to the borrower, and C) how much the lender will charge in terms of fees and interest.

These important factors include the borrower’s:

  • Credit score
  • Credit history
  • Debt-to-income ratio
  • Home price
  • Down payment amount
  • Income

The better the credit history, the more creditworthy a borrower is deemed to be. This means that you pose less risk to a lender, as you already have a history of paying your bills on time and fulfilling your financial obligations. As a result, borrowers with higher credit scores are offered lower interest rates, which means a lower-cost loan.

Interest rates and fees are also affected by the borrower’s down payment amount. The more you put down on a home, the less risk the lender is taking on by offering you a mortgage loan. Therefore, borrowers with a larger down payment are typically offered a lower interest rate on their loan and lower upfront loan fees.

This new ruling threatens the traditional underwriting and fee structure system, with many borrowers facing higher fees and costs even if they have a higher credit score and/or a larger down payment amount.

What Good Credit Borrowers Should Expect Moving Forward

According to Sandra Thompson, head of the Federal Housing Finance Agency, these changes will serve to “increase pricing support for purchase borrowers limited by income or by wealth.”

That’s all good and well, and will likely go a long way toward improving housing affordability for borrowers with limited or lower credit histories, or even those with a smaller down payment amount.

But what does it mean for borrowers who have spent years saving up and growing their credit score?

Well, amidst high home values, increased mortgage interest rates, and the effects of recent inflation, many of these borrowers with good credit will find themselves paying more under the new rule. LLPA rates may increase according to the borrower’s credit score and down payment amount, effectively penalizing them for their hard work. Depending on the loan amount and other factors, this could mean paying hundreds or even thousands of extra dollars each year.

What Borrowers Can Do to Offset These Added Fees

While new homebuyers can’t avoid the increased LLPA rates that go into effect on May 1, there are some general rules for keeping your mortgage rates — and therefore, your home buying costs — as low as possible.

  • Keep your credit score up. Even with LLPA percentages increasing for good credit borrowers, it still makes sense to maintain a healthy credit score. This is especially important if your credit score rating is already Good or higher, as your LLPA and mortgage interest rates may be less with an Excellent score than with a Good score.
  • Put down as much as you can. The lower your loan-to-value ratio (LTV), the lower your LLPA percentage and, often times, your mortgage interest rate. This ratio compares your home’s current market value to the loan amount you request, which is the amount left over after you contribute your down payment. The higher your down payment, the lower your LTV and the lower your rates can be.
  • Limit your home’s purchase price. LLPAs are a percentage-based fee, rather than a flat rate. This means you’ll see a higher dollar amount increase on a more expensive home. If you really want to limit your out-of-pocket costs, buy a less expensive home.
  • Opt for a shorter mortgage loan term. One factor influencing your home mortgage rate is the loan term choosen, or how long you want to pay off your home. A shorter loan term results in a higher monthly payment, but often a lower interest rate. A longer loan term often means a higher interest rate.
  • Shop around for the most competitive mortgage rates. No matter which home you’re buying, which terms you need, or what sort of fees and rules are imposed, you should always shop around before choosing a mortgage lender. Many of the best mortgage lenders allow you to get pre-qualified and see rates, without hurting your credit score. This gives you a rough idea of your home mortgage loan costs, as well as which lenders might best meet your needs.

Bottom Line

Home prices, property taxes, insurance premiums, and mortgage rates have all increased in the last year or two. Many soon-to-be homebuyers already feeling the effects, even before shopping around. This new federal ruling will result in even higher costs for a good number of those buyers, especially if they have good credit or a notable down payment amount.

Currently, there is no way around this new rule, which goes into effect at the beginning of May 2023. However, there are still some ways you can limit your home mortgage costs and find the (affordable) home of your dreams.

Should I Borrow Against My Home Equity With a HELOC?

Should I Borrow Against My Home Equity With a HELOC?

Your home’s equity is the value of the property that you own outright. This value asset often sits untouched until you sell your home. But with a home equity line of credit (HELOC), you can tap into that cash sooner and borrow against your home equity with a HELOC.

Here’s a look at how HELOCs work and whether you should use one to withdraw your own home equity.

What is Home Equity?

Equity is the portion of your home’s current value that you own, versus what a bank or lender still owns. Home equity is calculated by subtracting your remaining mortgage balance or other liens from the home’s current market value.

Say that you have a home that is currently worth $400,000. You have a remaining mortgage loan balance of $118,000, so your home equity is $282,000.

If you were to sell your home tomorrow, you’d get that equity in the form of cash at closing. What if you don’t plan to sell your home for a while, though? You can access that cash asset now by borrowing against your equity with a HELOC.

How a HELOC Lets You Access Your Home’s Equity

A home equity line of credit (HELOC) is a revolving line of credit that’s tied to the equity in your home. With a HELOC, you may be able to borrow as much as 70% to 90% of your home’s value, minus any outstanding mortgage or lien balances.

A HELOC comes in two stages:

  • Draw period —  The only stage you can make withdrawals in; the draw period typically lasts for about 10 years.
  • Repayment period — No new withdrawals are allowed, and you’ll need to begin repaying the balance on your line of credit. This phase usually lasts another 15 to 20 years.

Like a credit card, you can borrow against an open-ended HELOC up to the total credit limit. Withdrawals are allowed on-demand, so you can pull out cash as needed. As you make payments each month, you’ll free up your credit limit and can borrow again. If you never withdraw funds from a HELOC, you never have anything to repay.

As you borrow, your HELOC balance will be subject to interest charges. These are usually variable during the draw period and fixed during the repayment period, but that can vary from one lender and product to the next. Some lenders also allow you to lock in rates for specific withdrawals during the draw period. This protects you from unexpectedly rising rates.

Should I Borrow Against My Home’s Equity With a HELOC?

Deciding whether to borrow against your home equity with a HELOC is really a personal decision. To help you decide, here are a few questions to ask yourself (and why they matter):

  • How much equity do I have? HELOC lenders will only allow you to tap into a portion of your home’s equity. This is often around 80% of your home’s current value. If you only have 10% to 15% equity in your home, for example, you probably won’t qualify for a HELOC. If you own your home outright, though, a HELOC may give you access to more money than other debt products would.
  • When do I need the money? Unlike a personal loan or credit card, it can take weeks to complete the process of opening a HELOC. That’s because HELOCs require underwriting and (often) a new home appraisal. If you need funds fast, this product may not be right for you.
  • Will I be able to afford the monthly payments? If you default on a credit card or personal loan, you’ll impact your credit score. If you default on a secured debt like a HELOC, though, you put your primary home at risk. Be sure that you’ll be able to make those payments every month before borrowing money against your home equity.
  • When do I plan to sell my home? When you sell your home, any proceeds will first go toward paying off your first- and second-position lienholders, such as your mortgage lender and a HELOC lender. Any HELOC on that property will also be closed at that time; if you recently opened the line of credit, you may be subject to early termination fees and penalties.

Alternatives to a HELOC

Not sure if a HELOC is right for you? Here are some alternatives to consider.

Home equity loan

Both HELOCs and home equity loans allow you to tap into your home’s available equity. The difference is that a home equity loan gives you all of the cash upfront and in one lump sum, without the added cost of annual fees. You may be able to lock in a fixed rate on a home equity loan, too, giving you predictable monthly payments for a set loan term.

Personal loan

If you’d rather not use your home as collateral to secure a debt, a personal loan may be the answer. With a personal loan, you’ll get a lump sum loan to use as you see fit, sometimes as quickly as the same day. Personal loan terms may be shorter than HELOCs and interest rates can be higher, so be sure to weigh the costs of each before you decide.

Cash-out refinance

With a cash-out refinance, you are replacing your current home mortgage loan with a brand-new loan. The difference is that this loan is issued for a higher amount, allowing you to tap into a portion of your available equity and take “cash out” of your property. Your cash-out refi may have a different interest rate, repayment term, and monthly payment amount than your current mortgage loan, so take that into consideration.

Split the equity

Recently, companies like Splitero have offered a unique way to access your home’s equity now without the need to repay that debt right away. With Splitero, you are able to get up to $500,000 of your home’s equity in cash now, in exchange for an investment in your property’s future appreciation. There are no monthly payments to worry about and no minimum credit score requirement, either.

At the end of a 30-year term (or when you either sell or refinance your home), you’ll buy back that investment from Splitero, which includes a portion of your home’s new equity. Depending on when you sell, refinance, or opt to buy back the investment, this could be a more affordable option than a HELOC, especially if you want to avoid the added cost of monthly payments.

What Is A HELOC And How Do I Use It?

What Is A HELOC And How Do I Use It?

If you own a home, you will likely accumulate equity in that property over time. As its value increases and as you pay down your mortgage loan balance, that equity will increase. But rather than letting that equity sit unused for years, you can tap into it with the help of home equity products such as a HELOC.

Here’s a look at how HELOCs work, how much you can borrow with a HELOC, and what to expect from the process when you pull from your home’s equity.

What is Home Equity?

Your home’s equity is the value of the property that you own, versus what your bank still owns. To calculate equity, simply take your home’s current market value (what it’s worth) and subtract what you still owe on the property (any liens, such as your mortgage loan balance). The remainder is your home equity.

So, if you have a home worth $380,000 today and still owe $97,000 to your mortgage lender, you have $283,000 in equity.

What is a HELOC?

A home equity line of credit, or HELOC, is a revolving line of credit that is secured by the equity in your home. This line of credit uses a portion of your equity as collateral to secure the debt, and allows you to withdraw funds as needed for a predetermined period of time.

HELOCs typically have a set draw period, usually around 10 years, during which you can pull from the line of credit if and when you need cash. This isn’t mandatory, though, and you can technically leave a HELOC open without ever borrowing against the limit.

Once your draw period ends, the HELOC enters a repayment period, often lasting another 15 to 20 years. During the repayment period, you cannot withdraw any additional funds.

If you do pull cash from your HELOC, you’ll sometimes be required to make interest-only payments for the remainder of the draw period. Once the repayment period begins, you’ll make scheduled monthly payments toward both interest and the principal balance, as with any other installment loan product. And if you don’t ever pull any money from your HELOC, you don’t need to repay anything to the line of credit.

What You Can Use HELOC Funds For

HELOCs are secured by the equity in your home, but unlike other types of secured loans (like auto loans or your original home mortgage loan), the funds don’t have to be earmarked for any specific purpose. This means that you can use a HELOC for nearly any* purpose!

This means that you can use a HELOC to do things like:

  • Consolidate existing debt
  • Cover a home renovation project or necessary repairs
  • Make a large purchase, such as a new car or even the down payment on another home
  • Take your family on vacation
  • Pay your kids’ college tuition expenses
  • Provide you with a financial safety net, in case you ever need quick access to cash

The funds are pulled out of your HELOC via ACH transfer, paper check, or even using a dedicated debit card. This money can then be spent like cash, however and wherever you need it.

*Your lender may add verbiage to your HELOC agreement that prohibits you from using the cash for things like illegal activities. But otherwise, spend it however you wish.

How Much Can I Borrow With a HELOC?

Since a HELOC is secured by the equity in your home, you’ll need to actually have equity before you can borrow. And the amount you’re able to borrow will be a factor of that available equity.

If your home is worth $525,000 and you only owe $110,000 on your home mortgage loan, you have $415,000 in available equity. Lenders won’t let you borrow all of that, though, and will instead set a maximum loan-to-value ratio (LTV) limit.

In this example, your current LTV is 20.9%. If your lender only allows a maximum combined LTV of 80%, you’d be limited to a HELOC of $310,000.

$525,000 home value x 80% combined LTV = $420,000 maximum total liens

$420,000 maximum – $110,000 existing mortgage balance = $310,000 in available equity

This would still leave you with 20% in home equity, which helps limit your lender’s risk.

Depending on the lender, a HELOC may be offered on a:

  • Primary home
  • Secondary or vacation home
  • Investment property, such as a rental home
  • Single-family home
  • Multi-family home (like a duplex, triplex, or quadplex)
  • Condominium or townhome

The amount you can borrow may further be limited by the type of property you own. For example, a lender might allow a maximum LTV of 90% on a primary home, but only 65% on an investment property. Or you might get up to 85% LTV on a single-family home but only up to 60% on a manufactured home.

How Much Does a HELOC Cost?

There are a few potential closing costs to note when it comes to opening and using a new HELOC. Be sure to read your lender’s fine print to understand which of these may apply to you and, if so, how much it will cost you in the end.

HELOC Fees Purpose
Application or origination fee Covers the administrative costs of your new line of credit
Interest (APR) The interest charged on any borrowed funds; can be variable or fixed
Annual fee A recurring fee that is charged while your HELOC is open and available
Home appraisal fee The cost of ordering a home appraisal report, to accurately determine your home’s current market value
Early termination fee A penalty fee imposed if you pay off and cancel your HELOC too soon after opening the account (usually within the first 24 or 36 months)

Application or origination fee

A HELOC application or origination fee helps the lender cover the cost of underwriting and issuing your new line of credit. This fee is not as common as the others mentioned here, but may run from 0.5% to 5% of the total line of credit amount. This line item could also include smaller costs such as recording fees, notary fees, and credit report fees, depending on the lender.

Interest or finance charges

You will incur interest charges on your HELOC based on the amount borrowed, as with any loan. If you don’t ever tap into your line of credit, you won’t be subject to any interest. If you do borrow money, though, you’ll pay interest on that balance until it’s repaid. HELOC interest rates may be variable or fixed, and some lenders allow you to “lock in” rates at certain intervals.

Annual fee

Many HELOCs charge an annual fee for as long as the line of credit is open and available. Usually charged during the draw period, this fee ranges from $50 to $150 a year, on average.

Home appraisal report fee

In order to accurately determine how much your home is worth — and therefore, how much equity you actually have in the property — a lender will usually want to request an updated home appraisal report. This inspection is ordered by the lender and utilizes an unbiased, licensed inspector.

Following your home inspection, the lender will have an accurate idea of your home’s current market value. From there, they can subtract any liens on the property and calculate how much equity you’re allowed to tap into with your new HELOC.

Early termination penalty fee

Some lenders may cover a portion of your HELOC’s origination fees, or the upfront costs associated with opening and issuing the line of credit. If you pay off and/or close out the HELOC soon after opening it, however, you may be required to pay some (or all) of those expenses back to the lender.

Early termination penalties vary by lender and equity product, and might be a flat dollar amount or a percentage of the total line of credit limit. You may be subject to this fee if you close your HELOC within the first 36 months or so after opening the line.

HELOC Interest Rates

Since a HELOC is secured by the equity in your home, it can often have a lower interest rate than unsecured debt products, such as personal loans or credit cards. However, these interest rates are usually variable in nature, meaning that they are subject to change over time.

As industry benchmark rates rise (or fall), so too may your HELOC’s effective rate, particularly during the draw period. This can make it difficult to predict exactly how much those funds might cost you down the line, especially if you don’t withdraw cash right away. As of this writing, a good HELOC interest rate is anything in the single digits or lower teens… but this could easily change.

Many HELOCs have a variable rate during the draw period, but a fixed interest rate once the repayment period begins. You may also have the option to “lock” your rate at different intervals during the draw period. For example, your lender may allow you to lock in a fixed rate on up to three individual withdrawals, or to lock your current balance’s rate for a year.

The details will vary from one lender to the next, so it can be wise to shop around until you find the best HELOC rates and terms for your specific needs.

How HELOC Interest Rates Are Determined

So, how do you go about getting the lowest HELOC rates available? The answer is multifaceted.

Overall rates are established by the underlying index or Prime rate. As this benchmark changes, so do the rates that banks are willing to offer. This means that, regardless of all other factors, your HELOC rates can only get so low.

Locking in a lender’s lowest offered rate on a HELOC is then a factor of your own qualifications. Generally, the lowest possible rates are available to borrowers based on:

  • Excellent credit scores
  • Certain income and debt-to-income ratio (DTI) requirements
  • Location
  • Home type
  • Loan-to-value ratio (LTV)

What Credit Score Do I Need to Get a HELOC?

In general, HELOC borrowers will need to have good credit or better to get a HELOC, even though the line of credit is secured by the equity in their home. This often means having a credit score of 660 or higher.

Each lender sets its own requirements for borrowers, including the minimum credit score you’ll need to qualify. This requirement can also vary based on how much you want to borrow, your current DTI, and even the type of home you own.

HELOC Alternatives

Not sure if a HELOC is the best option for you? Here are some alternatives to consider.

  • Home equity loans — Both HELOCs and home equity loans enable you to pull cash from your property’s available equity. With a home equity loan, though, you’ll get a single lump sum loan with either a fixed or variable interest rate and set repayment terms. There are no annual fees and payments may be more predictable.
  • Personal loans — If you qualify, you could also consider a personal loan in lieu of a HELOC. This lump sum installment loan is unsecured, meaning that you aren’t risking your home if you default, and funding can be as quick as the same business day. However, loan limits may be lower — and interest rates higher — than with a secured HELOC.
  • Cash-out refinance — A cash-out refinance replaces your existing mortgage loan with a new, larger loan and gives you the difference back in cash. This may result in a different interest rate, repayment term, and monthly mortgage payment.

FAQs about HELOCs

What happens if I default on a HELOC?

A HELOC is secured by the equity in your home. So, if you default on this line of credit (fail to make payments as agreed) the lender can initiate the foreclosure process. If this happens, you could lose your home to satisfy any outstanding liens, including your HELOC and your mortgage loan.

How long does it take to get a HELOC?

It often takes between four to six weeks to complete the HELOC process and get access to your home equity funds. This includes the application, underwriting, and appraisal.

How much can I borrow with a HELOC?

Lenders may allow you to borrow as much as $2 million against your home with a HELOC, but only if you have enough equity on that property in the first place. Lenders often have an LTV limit of 80% to 85% on a primary home, or lower on secondary and investment properties.

Can I get a 100% LTV HELOC?

Select credit unions will allow you to take out between 90% and 100% LTV with a HELOC, but these are very limited and are only available to members. Generally, the LTV limit on a HELOC ranges from 75% to 85%.

How much are HELOC payments each month?

During the draw period, HELOCs often require interest-only payments according to how much you’ve withdrawn and your current interest rate. Once your HELOC enters the repayment phase, you’ll need to make monthly installment payments on both the principal and interest, through the remainder of the HELOC term.