By David McGarry
Borrowers pay interest and fees in large part to compensate the risks incurred by financial institutions during the loan process. For example, a borrower with a sparkling credit history and significant savings presents little risk of default. Thus, they can often obtain funds on highly favorable terms. On the other hand, a borrower with murky credit and little cash will likely pay a premium. This all is dictated by common sense and the basic laws of economics.
Nonetheless, effective this month, the Biden administration will financially penalize mortgage borrowers with good credit to subsidize those without it. The administration hopes the move will encourage more low-income Americans to purchase homes. However, this sort of government intervention will disrupt critical workings of the market machine. It is also deeply unfair to those home buyers who, through hard work and thrift, have earned their good credit. And the last time the government incentivized credit-risky people to buy homes, the country experienced the subprime mortgage crisis.
The new rule will upcharge many buyers with credit scores above 680, particularly those whose down payments range from 15 percent to 20 percent. For example, “a home buyer with a 740 FICO credit score and a 15 percent to 20 percent down payment will face a 1 percent surcharge – an increase of 0.750 percent compared to the old fee of just 0.250 percent,” the New York Post reports. Such a buyer, with a $400,000 loan at 6 percent interest, will likely pay an extra $40 per month, or $480 per year. Alternatively, under the revised policy, borrowers with subpar credit could save thousands in closing costs. A low credit score that previously would qualify the buyer for a 2.75 percent fee will now qualify the buyer for a 1.5-percent fee. An even lower credit score will now result in a rate of 1.75 percent, down from 3.5 percent.
The updated fee structure will “increase pricing support for purchase borrowers limited by income or by wealth,” says FHFA Director Sandra L. Thompson. However, as an economic matter, such limitations serve as critical negative incentives for consumer behavior. In other words, a lack of cash or good credit should, in fact, discourage one from purchasing a home. If one lacks the requisite financials to purchase a home, improve them. Credit ratings aren’t a static caste system. To raise one’s score, one need only spend responsibly and get rid of debts punctually. Similarly, while amassing the cash necessary for a down payment requires hard work and fiscal discipline, it’s a widely attainable goal. Economic opportunity and upward mobility are robust in America despite the recent popularity of fear-mongering to the contrary.
Government subsidies remove such incentives to maintain personal financial hygiene. Instead, they encourage individuals to make riskier financial decisions – resulting in more mortgage defaults – and can disrupt the economy at large. This exact narrative unfolded catastrophically in recent memory, contributing the subprime mortgage crisis of 2007–2008.
Moreover, cutting the costs of obtaining a mortgage could pump still more air into the already over-inflated American housing market. In the first quarter or 2023, the national median price of a house was $436,800, just under the previous quarter’s record-setting figure of $468,000, according to federal dat
The desire to blunt the difficulties such prices present to perspective homebuyers with government assistance is understandable but misguided. High prices, while unquestionably painful, are essential to the healthy functioning of any economy. A high price informs consumers that a given resource is in great demand. It encourages them to consume less of it, or to seek a substitute. Thus, high prices de facto reduce demand for sought-after resources and ration those resources to the individuals who value them most or are most reasonably able to afford purchasing them.
However, if government intervenes to lower a price – or, in this case, lower an associated fee – consumer demand won’t abate. The persistence of the underlying economic factors that raised the price in the first place will remain. “When you create the ability to buy more housing because you’re mispricing the risk, and there’s a constraint on supply – which we have – Economics 101 says if you increase demand and supply is constant, prices have to go up,” Ed Pinto, director of the Housing Center at the American Enterprise Institute, told The Dispatch.
Unfortunately for President Biden, bureaucrats cannot suspend the laws of economics for convenience. The workings of markets are intricate and far-reaching. Ill-conceived subsidies, however well-intentioned, too often trigger legions of unintended consequences.
David B. McGarry is a policy analyst at the Taxpayers Protection Alliance.
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