When borrowers initiate their search for financing, they most often call about interest rates. Loans have always been priced according to the perceived risk for the lender. In the past, credit scores were a major determiner of loan terms and pricing. With high credit scores, borrowers could often obtain financing with the “best” loan rates or even on a stated or no-doc basis.
Lenders now consider borrower’s credit scores as well as the Loan-to-Value of the new loan in what is being called risk based pricing. Mortgage lenders must consult a grid to determine the pricing. As credit scores reduce and LTV levels increase, the lender’s perceived risk increases and is accommodated via an increase in the pricing/interest rate.
FHA, for a long time, resisted adopting a risk based formula for borrower loan approval. Beginning in 2010, FHA concluded that they had to also initiate risk based approval practices in an attempt to improve the quality of their loan portfolio. While VA has not yet adopted any such procedures, they have adopted (as have all lenders) a minimum required credit score.
The danger for a would-be borrower is that they will receive an interest rate quote based upon the optimum conditions and be disappointed when their “profile” requires what we call “pricing hits” and the interest rate quote increases.
The danger is equally existent for real estate professionals who quote the best rates only to discover that their borrower is ineligible for the rate due to credit or other conditions.
Here is an example of how risk based pricing can affect a borrower. Any additional risk cost is added to the “cost” and not to the rate for the loan. Let’s price a loan for a borrower with a 725 credit score. S/he is acquiring a 75% LTV cash-out refinance transaction. There will be a 45 day lock period and the borrower prefers not to have the loan impounded for taxes and insurance. The pricing adjustments are identified in bold on the grids.
Agency FICO/LTV Grid
| Credit Score | <=60% LTV | 60.1-70% LTV | 70.1-75% LTV | 75-80% LTV |
| 740+ | -0.25 | 0.00 | 0.00 | 0.25 |
| 720-739 | -0.25 | 0.50 | 0.25 | 0.50 |
| 700-719 | -0.25 | 0.50 | 0.75 | 1.00 |
| 680-699 | 0.00 | 0.50 | 1.25 | 1.75 |
| 660-697 | 0.00 | 1.00 | 2.00 | 2.50 |
| 640-659 | 0.50 | 1.25 | 2.50 | 3.00 |
Agency Cash-Out Refi FICO/LTV Grid
| Credit Score | <= 60% LTV | 60.01-75% LTV | 75.01-80% LTV | 80.01-85% LTV |
| 740+ | 0.00 | 0.25 | 0.50 | 0.625 |
| 720-739 | 0.00 | 0.625 | 0.75 | 1.50 |
| 700-719 | 0.00 | 0.625 | 0.75 | 1.50 |
| 680-699 | 0.25 | 0.75 | 1.50 | N/A |
Affect on Borrower’s Interest Rate
| 30 day lock | 45 day lock | No Impounds | Additional Add (above) | Total Cost |
| 0.125 | 0.325 | .25 | 0.875 | 1.45 |
The above is the pricing to the lender in addition to the typical origination fee. The above “hits” to pricing accommodate the credit score, loan-to-value, the lock period and the fact that the borrower prefers not to be impounded. Other price adjustments would occur if the property is multiple units.
It is easy to see that rates should not be quoted until the borrower’s loan profile and expectations are clearly identified. While frustrating to borrowers shopping for the “best rate”, unless the lender has all of the supporting documentation prior to quoting a potential interest rate, one cannot depend upon the information.