Starting May 1st, 2023 those with good credit will pay a 1% fee on new mortgages while those with poor credit will receive a 1.75% discount – will this spread to credit cards too?
Good Credit Penalty Starts May 1st
A new Federal rule goes into effect in just over a week that will penalize new home buyers with a credit score above 680 by 1% in mortgage fees and provide a discount to challenged credit of 1.75%.
“Starting in May, a new federal rule will upend the current structure of the Loan-Level Price Adjustment (LLPA) matrix. Homebuyers with a good credit score could see their monthly mortgage payment rise by over $60 a month, while riskier borrowers will get more favorable mortgage terms because their fees were reduced. It’s a move the Federal Housing Finance Agency (FHFA) hopes will address housing affordability challenges in the U.S., but it’s come under scrutiny for being unfair and potentially ineffective.” – Newsweek
Most of the examples I have seen add $40/month on a 30-year note for a $400,000 home.
It is my understanding that this will only effect new mortgages as current mortgages are locked in to prior terms but I couldn’t find concrete clarity on this in a number of articles nor on the Fannie Mae website. I looked for the basis of this federal rule and was unable to surface it (please comment if you have it) but I question if this isn’t based on law, how it will hold up when challenged in court. For what it’s worth, the student loan forgiveness effort the White House has undertaken is still on hold but some speculated this weekend that it will be struck down.
I’ll leave that for lawyers and talking heads to speculate.
Bad Credit Subsidizing Good Credit For Travel Rewards Cards
There was a study in 2021 that suggested those with poor credit scores were subsidizing credit card rewards for less profitable, high credit score cardholders. The theory of that study was as follows:
“When you pay with a rewards card at the bodega, the guy paying in cash behind you is picking up the tab Credit card issuers — think American Express, Chase, and Citi — make money in three main ways: fees, like annual ones to have the card or penalties on late payments; interest on unpaid credit card bills; and interchange fees, meaning the amount they charge every time you swipe plus a small fixed fee. Generally, issuers charge about 1 to 3 percent of the total transaction amount. These swipe fees can be big moneymakers for some companies: American Express clocked $24 billion in them in 2018 alone.” – Vox
In essence, because those without high credit scores pay with cash, (low fee) debit cards, or prepaid cards – they absorb the price increases of those who pay with a credit card (for which the vendor incurs a 1-3% fee) as everyone pays the same price for goods. This ignores the 3% fee which many vendors have added to those paying by credit card, though this is not universal
That article (widely published and republished) is a stretch to say the least, but feels very similar to trying to shore up the inequity in the homeownership market.
Will The Penalty/Discount Spread?
The question is whether or not this rule (or its clones) will spread to other areas of finance. The same inequity that the mortgage sector identifies extends to credit cards, perhaps even more so.
Some would argue that travel rewards credit cards already issue fees for members who qualify. Typical approval credit scores for high annual fees like the Chase Sapphire Reserve are around 700-720 anyway and cardholders are paying $550/year for the associated perks. Those with scores below 680 would not likely be approved so if such a fee were passed on, the corresponding discount wouldn’t apply because those applicants wouldn’t be approved anyway.
Travel rewards credit cards are a key component for most frequent travelers and an increase in interest rate would only go to the bank’s bottom line. A reduction of the annual fee for those who can qualify for cards with a lower credit score may make credit cards more attainable for some, but that only works if those with higher credit scores continue to sign up or maintain their membership.
Much like subscription bloat, many of us have credit card annual fee bloat and will make choices of which cards to maintain and which to abandon. I personally have three on the list to discontinue or move the product including at least one premium card. Increasing the costs would expedite my own personal flight.
Further, if the same penalty/discount structure came into effect but only to interest rates, that would force banks to subsidize the discount as high score cardholders are less likely to carry a balance and could not offset the discount applied to challenged credit cardholders. Making cards obtainable for the riskier applicants adds costs and risks to the bank as well. It’s also possible that more cardholders who are not yet financially prepared for credit cards, their annual fees, late payment costs, and high interest rates could move from 0% debit cards and cash to 20+% interest rates and climbing.
Lastly, while borrowers have the power to manage their credit scores by paying bills, they ultimately do not control FICO scores. Borrowers who are paying rent, cell phone bills, insurance, and keeping their head above water have little to show for it on a credit report (outside of niche systems that attempt to demonstrate paying some bills.) A first time borrower that has zero credit history might start at a 681 credit score and find themselves paying more than if that arbitrary number were one point lower despite a complete lack of history.
I’m not familiar with an historical precedent for charging those who have a stronger history of paying their bills more than those who don’t. However, the rule has been approved for mortgages and begins shortly, spreading to the rest of the financial system seems like the next logical step.
What do you think? Will the same approach apply travel rewards credit cards? Is it legal to charge more to those with better scores and discount for those who have lower scores? Is it ethical?