There have been many consequences of the subprime mortgage meltdown. But one which has received very little attention so far is the repricing of risk by investors who buy mortgages. That is about to change. What’s important to understand about this fuzzy term is that mortgage rates will now rise even for consumers with decent credit scores. Meet risk-based pricing.

In the 2007 mortgage meltdown, investors realized that the low interest rates previously offered didn’t adequately cover the risk of default. Past projections floated on a rising tide of appreciation that kept every one off the reef. Now that the tide has rolled out and shipwrecked many lenders, those left afloat are raising rates to compensate for the soaring level of defaults.

Are You an “A Paper” Borrower?

Long before subprime came along, there were two general categories of mortgages; “A Paper”, and everything else. Those of us involved in “A Paper” lending rarely visited the dark underworld of B, C, & D paper. But the advent of subprime brought light to that world and introduced us to risk-based pricing as the industry opened wider the gates of home ownership. So think of the current repricing of risk as a further striation of the A paper segment. This will mean that higher risk borrowers will now pay higher rates.

Pricing Adjustments

The long and short of this is that A Paper borrowers will no longer be treated equally. For instance, if Fannie Mae’s Desktop Underwriter (DU) approves your loan and your Fico score is below 620, expect to pay a rate 1/2 point higher than your friend whose score is 720, unless you’re putting 30% down. If you want an interest-only loan, a hybrid ARM, an owner occupied duplex, or a manufactured home, expect further adjustments to your rate, depending upon your loan-to-value (LTV) ratio.

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