Why Mortgages Will Soon Be More Expensive

Homebuyers are in a sudden headwind of rising home prices, mortgage rates and lending limits.

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Homebuyers are somewhat suddenly fighting a strong tide. House prices and interest rates have been moving higher while incomes have barely budged—and now lenders are set to stiffen the fees on those with smaller down payments and a less-than stellar credit score.

This week, the mortgage giants Fannie Mae and Freddie Mac announced new guidelines that could add as much as a half point to the interest rate that a fixed-rate borrower pays. Fannie and Freddie do not originate new mortgages. But they buy about two-thirds of the conventional mortgages that banks underwrite.

The tougher lending rules are set for March. But banks will begin phasing them in next month, when another set of federal rules known as ability-to-repay and the qualified mortgage also kick in. These rules establish stiff penalties for banks that write unconventional mortgages that later go bad. That means banks have less wiggle room to work with borrowers that may be self employed, at a new job or paid on commission. On top of all this, the Fed in January will begin winding down its bond-buying program, which has helped keep mortgage rates low.

Lewis Ranieri, co-inventor of the mortgage-backed security, called the timing of Fannie and Freddie’s move “impeccably bad.” Mike Fratantoni, chief economist at the Mortgage Bankers Association, says next year “on net, it will be getting tougher to qualify for a mortgage just on the economics.”

Let’s start with that potential half point bump in mortgage rates. That’s the difference between a FICO score below 660 and one over 800. On a $200,000 fixed-rate loan for 30 years, the monthly payment at a 4.5% rate would be $1,013.37. At 5%, it would jump more than $60 to 1,073.64. Over the life of the loan the extra cost would be $21,697.

Fannie and Freddie have a floating grid of cost hikes for borrowers up and down the credit spectrum and for those with down payments below 20%. For example, a borrower seeking a 30-year fixed-rate mortgage with a credit score of 735 and making a 10% down payment would pay about .4 percentage points more—4.9% instead of 4.5%. A bigger down payment would help but even with 25% down a borrower with a credit score below 760 would pay a premium rate.

The biggest impact, though, will be felt from rising prices and mortgages rates. After jumping about 12% this year, home prices should rise another 5% in 2014, says Fratantoni. He also believes that as the Fed tapers its bond buying, 30-year fixed mortgage rates will jump from around 4.5% today to 5.5% in 2015. Both those paces far outstrip pay raises expected to be just 3% next year, making a mortgage that much tougher to get.