Fannie MAE and Freddie Mac have gone to risk based pricing. This is not new news as loans have always been priced and approved based on levels of risk. When you as a consumer are looking to be financed the lender is evaluating three things. We refer to them as the three c's.
Credit - this is your history of repayment of other loans such as auto, note loans, installment, student loans and revolving debts such as credit cards. Your mid fico score is seen to be a fair reflection of your repayment history. Experian, transunion and equifax are the three bureaus who produce these snapshots in time that generate your scores.
Collateral - this refers to the property and the down payment or equity position you are in. Having 20% equity in a home is considered the breakeven point for a lender in the event they have to foreclose. Naturally the greater the equity the lower the risk. Someone with 40% plus is not likely to let a home slip away and has the ability to price to sell if they get into a dangerous position.
Capacity - this is your ability to repay the debt. Your income, more importantly claimed documentable income is what they are looking for. This is the arena that was most widely abused in recent years and as a result has become the most scrutinized and most important. Income is only part of capacity as length on the job, type of job and how you are paid are additional factors that are very important. Your debt to income ratio is your housing and other credit related minimums divided by your gross monthly income. The goal is to not have this exceed 43%. that means that the house and all the debt represent 43% of your GROSS income.
Traditionally, if you he a 620 fico score, 20% equity position and documented your income on a purchase you would qualify for the lowest wholesale rates we have to offer. However, this has changed drastically and it is undergoing another set of revisions.
Today you have to have a 740 fico to be in the top tier and from there it drops off fast. Those who want to refinance and take no cash out of their home with a 695 fico and 20-25% equity have to pay a 1.5% risk adjusment. This means that their par wholesale rate will be much higher than those with 740. Yield spread premiums are paid to brokers by wholesalers for selling higher rates or to absorb these costs. (another blog entirely) today the Ysps are not large enough to cover that 1.5% so the costs are passed on to the client making loans more expensive.
This one example is a cheaper example of the pricing adjustments that have been passed onto us all. So although rates are low it does not mean that you will get a low rate or if you do you may have to pay for it. Raising costs and adjustments is just one way for these companies to make up for losses.
The end result is that government loans such as FHA, VA and USDA do not impose such adjustments. Do not he suprised if your broker or loan officer tells you that FHA may be a more cost effective approach to financing your home. As always consult your professional and ask them to explain or show this to you in a manner that makes sense.
Good luck and until next time.
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