The introduction of lender choice of credit score at mortgage origination is expected to change both underwriting processes and mortgage pricing, as credit scores influence not only default risk but also prepayment speeds and, ultimately, the price and interest rate of a mortgage at origination.
Lender choice will result in higher credit scores being used for loan pricing on a material population of mortgage applications, which can bias loan-level price adjustments (LLPAs) and reduce the guarantee fees collected by Fannie Mae and Freddie Mac (the Enterprises). It is likely that LLPAs will be increased to offset this bias. In addition to higher LLPAs, the introduction of lender choice increases uncertainty for investors and servicers, and both parties will adjust prices, resulting in higher mortgage interest rates.
In this analysis, it is estimated that mortgage rates could increase by 0.125% or more, excluding potential LLPA adjustments. The size of the increase will depend on the size of the risk premium required by investors and on lender strategies for absorbing pricing adjustments or passing them along to borrowers. For an average conventional mortgage ($375,000 loan amount, 6.00% interest rate and 30-year term), this means the borrower would pay $363 more in interest each year. Assuming a seven-year average life of the mortgage, a 0.125% higher interest rate is approximately $2,500 in higher average interest expenses.