When you and a spouse or partner apply together for a mortgage, could you be leaving money on the table by paying too high an interest rate because of a poorly understood lending practice?
New research from the Federal Reserve suggests the answer could be a costly yes when one individual has a much lower FICO credit score than the other. That’s because lenders generally are required to price loan applications based on the lower FICO score, not the higher.
If you’ve got a 780 score — sterling credit on FICO’s scale of 300 to 850 — but your partner has a sub-par 630 score, the lender will probably charge an interest rate keyed to your partner’s lower score. This “minimum FICO” rule, as it is called, is followed by mortgage insurers, lenders and major investors such as Fannie Mae and Freddie Mac, but it often is not known to first-time loan applicants and others who have not participated recently in the mortgage market.
The net result of this risk-based pricing practice, according to researchers, is that large numbers of joint borrowers have essentially paid more than necessary for their mortgages during the past decade.
Examining an unusually large and detailed database of nearly 604,000 conventional home mortgages from 2003 through 2015, economists found that “nearly 10 percent of prime borrowers who applied for their loans jointly could have lowered their mortgage interest rate at least one-eighth of one percentage point if the mortgage was applied for by the applicant with a higher credit score and an income high enough to qualify for the mortgage.”
Among joint applicants when one partner had a score below 740, “more than 25 percent could have significantly reduced their borrowing cost by having the individual with a higher credit score apply,” researchers said. Although they estimated higher payments in such cases of up to $1,400 a year, current credit-score-interest-rate survey tables published on Myfico.com, FICO’s consumer-facing website, illustrate how large loan amounts can lead to more money left on the table.
A $300,000 30-year fixed-rate mortgage in Illinois, underwritten using a 760 FICO might have qualified for a 3.3 percent rate quote and a $1,309 monthly payment of principal and interest at the beginning of April, according to Myfico.com. If the application were instead underwritten using a score of 650, the rate quote might be around 4.3 percent with a $1,485 monthly payment. Annualized, that comes to $2,112 in higher costs — in this case solely because the couple opted for a joint application and the 650 score raised the rate.
To avoid the minimum FICO rule, one of the partners must have sufficient income to qualify for the entire loan amount. You might think that’s not commonplace, but out of the roughly 604,000 loan files with joint applicants, 249,000 couples either had one person with a higher FICO and sufficient income to qualify, or both partners could qualify individually on income with even one having a lower score. Of these, 1 out of 10 joint applicants could have saved money by applying using the higher FICO.
So how would so many applicants have ended up with higher costs than necessary? The Fed study didn’t address this issue, but clearly large numbers of borrowers either did not know about the minimum FICO rule — no one told them about it — or they had other reasons to apply jointly.
Bob Walters, chief economist and vice president of the Capital Markets Group for Quicken Loans, told me in an interview that many married and unmarried couples may feel a strong psychological need to have both names on the mortgage note. They are buying the house together and there’s a feeling of joint ownership that’s important to them, even though both could be on the legal title to the house without both being on the mortgage.
Also, Walters observed, if one partner has a low FICO, he or she would probably see an increase in the score as the couple makes regular monthly payments. If that partner were left off the note, there would be no improvement to that lower score.
Paul Skeens, president of Colonial Mortgage Group in Waldorf, Md., agrees that couples need to know about the minimum FICO rule before committing to a joint application. But he argues that the loan officer working with the couple has the prime responsibility to alert them to potential savings.
Loan officers “shouldn’t just be order takers,” Skeens says, “They need to advise [clients] on how to get the best deal” — something the data in the Fed study suggest hasn’t happened enough.