September 22, 2013

Mortgage prices are affected by a variety of factors, some of which potential borrowers understand a lot better than others. For example, most mortgage borrowers understand that the price of a mortgage is different for different mortgage types. On Sept 20, 2013, for example, the best interest rate on mortgages with no fees was about: 

·         4.375% for a 30-year fixed-rate.

·         3.375% for a 30-year adjustable rate with the rate fixed for 5 years.

·         3.5% for a 15-year fixed-rate. 

Most potential borrowers also understand that prices vary over time as economic conditions change. For example, the best rate on a no-fee 30-year fixed-rate was about: 

·         9.7% in September 1990

·         3.3% in December 2012

·         4.375% in September 2013

However, many potential borrowers do not understand how the price of a specific type of mortgage, at a specific point in time, varies with the features of the transaction. There is always a “best price” for a transaction that is viewed as least risky to an investor, and there is your price, which could be the best price but may well be higher. This is illustrated in the table below, which was developed from a new feature recently added to my site.  

Pricing of Different Transaction Features of 30-Year Fixed-Rate Mortgages

On a $300,000 Property, September 20, 2013

Feature	Best	Yours	Interest Rate Adjustment
Location of Home	Texas	California	.018%
Loan Amount	$225,000 & Below	$255,000	.033%
FICO Score	800	620	.401%
Loan Purpose	No-Cash Refinance	Cash-Out Refinance	.401%
Property Type	Single Family	Condominium	.100%
Occupancy Type	Primary Residence	Investment	.502%
Lock Period	30 days	60 days	.033%
Total Adjustment			1.489%

 Upward price adjustments are very closely related to qualification requirements, in the sense that the same factors affect both.  In general, the larger the number of transaction features that require a higher price, the greater the likelihood that the loan will be rejected. In developing the table, however, I wanted to emphasize the major features that affect the price, so I ignored the warnings the program gave me that the full set of features would lead to rejection. Lenders will make loans with some of the features in the table but will not make a loan that has all of them. 

The state in which the property is located affects the price because of differences in state laws relating to foreclosures and other factors that affect the cost of servicing a mortgage. These price differences are small, however.  

Given the value of the property, the loan amount affects the price by changing the loan-to-value ratio (LTV), which is a major determinant of the risk of loss to an investor.  The transaction in the table has a ratio of 85%, which means that the borrower will not only have to pay for mortgage insurance (not shown in the table), but will also pay an interest rate a little higher than the rate on an LTV of 75% or lower. 

As shown in the table, the low credit score of 620 raises the mortgage price considerably, reflecting the documented relationship between credit score and the probability of default. A score below 620 generally results in rejection, and the 620 score in conjunction with the other risk features of the transaction shown in the table would also result in rejection.  

The only loan purpose that carriers a price penalty is extracting cash on a refinance (“cash-out”). The need to withdraw cash is viewed as an indicator of financial weakness that increases the likelihood of default. However, the combination of a cash-out refinance and a low credit score will result in rejection.  

Loans secured by condominiums are considered riskier than loans secured by single-family loans. Condo owners bear additional risks associated with the financial status of the condominium project as a whole. Loans on 2-4 family homes are also priced higher because the additional units are rentals. 

Loans secured by second homes are considered riskier than loans secured by a borrower’s primary residence, and loans secured by investment properties are the riskiest of all. The underlying presumption is that if the borrower’s finances become strained, preserving the primary residence will have a higher priority, a second home would have second priority, and an investment property would have the lowest priority of all.  

Borrowers shopping for a mortgage should compare the price of their loan with the best price, because there may be things they can do to reduce the price.  

For example, a borrower with a credit score of 659 could reduce her mortgage price by raising her score by only one point, which might be possible merely by shifting some credit card balances from one card to another. Another  borrower might find a less-costly way to raise cash once she realizes that the higher price of a cash-out refinance is paid on the entire new loan amount, not just on the loan increase required for the cash advance.  

The price adjustment process also carries an important implication for borrowers who believe that they can shop for a mortgage by requesting loan officers or brokers to quote prices. Unless the request for a price quote is accompanied by a complete list of the relevant transaction features, the shopper will be quoted the unadjusted price. For many if not most borrowers, that is not helpful.  

So where can borrowers go to find out how the price of their transaction compares to the best available price? While the raw data are contained in the pricing systems of all lenders, distribution is limited to loan officers and mortgage brokers, who use it to price loans but (with some notable exceptions) not to educate borrowers.  

To fill this void, I recently added this facility to my web site. To my knowledge, it is the only source of transaction-based price adjustments available on the internet. Users are warned whenever a set of transaction features would result in outward rejection rather than a price increase, and is referred to the qualification page where they can find where they crossed the line and how to get back.