Cheaper Homes Just Got More Expensive

One of the US’s largest banks made a subtle, but important change last month that could have big implications for entry-level homebuyers. That bank raised the cost of mortgages on lower priced homes significantly. If this change is adopted system wide, it could create headwinds for first-time buyers. However, it would behoove REALTORS® to work with their preferred lenders or to seek out new lenders willing to support entry-level buyers. Additional supply and slower investor demand could help ease pressures as well, while supporting homeownership.

A Fee Increase

In early May, Wells Fargo changed its adds-on fees, known in housing finance as an “overlays”, for loans guaranteed by the Federal Housing Administration (FHA), the Veterans Administration (VA), and the Rural Housing Service (RHS). These fees are in addition to those charged by the FHA, VA, and RHS. The changes include new fees for those borrowing less than $140,000 and a split between borrowers with credit scores below 700 and those over 740.

As depicted below the fees (converted to rates) for homebuyers who borrows less than $140,000 and who have less than a 700 credit score (orange) rose dramatically in May, while they fell modestly for those with scores greater than 740. Fees for borrowers of loans greater than $140,000 and credit scores greater than 740 were unchanged, while those with scores under 700 saw a modest decline in fees (grey). Wells Fargo does not originate government loans through its wholesale channel with credit scores below 640.

Wells Fargo was one of the few large national banks to enter and to support the entry-level portion of the market following the recession, while other large banks sat on the sideline. It has since pulled back and the void left by it and other large national banks was been filled by credit unions and non-bank lenders. While a few lenders and funders have similar overlays, Wells has the largest reach and its actions could set a precedent for other lenders.

What do the rate changes mean? Most borrowers would see no change, while a few would actually see a modest improvement. However, homebuyers with loans less than $140,000 and with credit scores below 700 would feel the pinch. A borrower with a 680 to 700 credit score and a $120,000 mortgage would see their monthly payment rise by $17 or nearly 3%, while the payment would jump by $39 each month for a borrower with a 640 to 660 credit or more than 6%.

Sizing the Effect

The share of purchase mortgages for owner-occupants in 2015 that were below $140,000 was just 10.3%. However, the FHA, VA, and RHS guaranteed more than half of these loans and they are more likely to support the moderate and lower credit borrowers.

The market for homes under $100,000 is one of the tightest in the housing market. While Wells Fargo is only one lender and has a smaller share of the government business, its actions send signals to the industry. Broader adoption of these pricing changes would raise costs to a large swath of homebuyers.

The areas most impacted by the change are smaller markets in the Southeast and Southwest. Of the top 10 markets by share of purchase mortgages under $140,000, three were in the Southwest and five were in the Southeast. In all of these markets, the government share of mortgages was over 70%.

Wells Fargo has a large presence in the market leading both the retail (5.4%¹ market share in the 1st quarter) and wholesale/correspondent (13.8%) lending channels.  Its wholesale presence means that Wells Fargo buys loans from other banks, brokers, and non-banks and packages them for resale into the secondary market. As a consequence, some local lenders with whom REALTORS® work may increase their fees, while others may not. As a result, REALTORS® could begin to probe lenders about their funding and find those that still charge reasonable fees.

Entry-level buyers face rising mortgage rates and slim supplies and now some will see their borrowing costs rise further. While these borrowers do not appear to pose a rising risk to lenders, regulatory risks and strong investor demand may have driven the change. Regardless, buying a home just got tougher for some homebuyers, but REALTORS can still do something about it to aid their clients.