Why You Don’t Qualify for the Lowest Interest Rate? – Risk Based Pricing
Everyone is looking for the elusive lowest interest rate in the market right now, right? What exactly does it take to get the “lowest rate” when purchasing or refinancing your home?
Low Mortgage Rates are Currently Available!
You literally couldn’t ask for better financing than today’s rate environment. Mortgage rates are at all-time lows thanks to aggressive action taken by the Federal Reserve. The Federal Reserve indirectly controls the general level of interest rates by raising or lowering short term rates.
Why Did My Neighbor Get a Lower Interest Rate Than Me?
So rates are low, this is not new news but why might you get a rate that is different from your neighbor? Essentially every bank sells the same product so technically everyone should get the same rate, right? WRONG! There are actually a number of factors that go into pricing a conventional mortgage loan. Too many to cover in one blog post but a big reason why is Fannie Mae and Freddie Mac, the mortgage corporations that ultimately buy and sell these loans, have what is known as risk based pricing.
Your Credit Score and Risk Based Pricing
Credit scores are the biggest factor in pricing your interest rate. With the current risk based pricing your closing costs will be higher if you have a lower credit score for the same exact rate.
Rates are priced out in basis points and you will be charged more basis points for a loan if your credit score is low. This means that you may have to pay a higher premium than your neighbor if you have a lower Fico Score.
Let’s say you are buying a house for $500,000 and putting 25% down. You call a loan officer to get a quote and let him know you have a 740 fico score. Your loan amount is $375,000. Your loan officer quotes a rate for a loan around 3.75% with “no points”. This means you would not be paying any discount points to get a lower rate. Then he runs your credit and low and behold, a collection popped up from a cell phone bill you thought was paid when you transferred service providers but somehow the check was lost in the mail and 2 years have gone by. You now have a 620 Fico score and it isn’t changing anytime soon.
This severely impacts loan pricing. With Fannie and Freddie’s risk based pricing you are now looking at a 3% or 300 basis point hit to your interest rate pricing which means you need to pay 3% of $375K now to close the loan at the same rate! $ 375K x 3% = $11,250 in closing costs to get the same rate as you would have had with a 740 fico score!!!
What I am about to share with you is TOP SECRET…It is a chart showing how risk based pricing will affect your loan pricing. The left column shows credit scores and the top shows the loan to value of your property.
So you can see the borrower with the highest credit score AND most equity will always get the lower rate because that borrower is less risk.
Three other Factors that affect Mortgage Interest Rate pricing:
- Occupancy: Is your home Owner Occupied, a Second Home or an Investment Property? You will get better pricing when financing an owner occupied property or second home.
- Property Type: Is this a Single Family Dwelling? A 2- 4 unit? A Condo? You will receive better pricing on a single family dwelling over units. Often times a 2 unit property will be the same pricing as a single family dwelling with certain lenders. This is one good reason to use someone who can broker loans as well as have direct banking channels as they usually can get around these hits to your loan pricing.
- Cash Out? Borrower who are cashing out to a higher loan to value will also experience higher pricing.
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