If you've ever wondered why a loan officer can't give you an "advertised rate", it's not necessarily because of an intricate bait-and-switch scheme. Most likely, you're being offered a higher mortgage rate because of something called Loan-Level Pricing Adjustments.
LLPAs are interest rate adjustments based on a person's individual risk to a lender.
Since first introduced by Fannie Mae and Freddie Mac in April 2008, loan-level pricing adjustments have been a constant cause of consternation among conforming mortgage borrowers. LLPAs are relatively new and aren't Prime Time news. Therefore, most people hear of them for the first time at the point of mortgage application and they don't like what they hear.
LLPAs can raise a person's mortgage rate by a full percentage point or more.
My clients have found the simplest way to think about Loan-Level Pricing Adjustments is in terms of auto insurance. For all of us, there is some base rate for which we all qualify. From there, however, adjustments get made -- drive a riskier car, pay a higher premium. Have a history of accidents, pay a higher premium. Things like that.
The same goes for mortgage loans.
Riskier loan characteristics increase the risk of a default claim. Fannie Mae and Freddie Mac created the LLPAs to help offset that risk. A few of the risk-based characteristics that can change a person's mortgage rate include:
- Condo loans with less than 25% equity in the home
- Credit scores less than 740
- Living in a 2-unit, 3-unit or 4-unit home
- Using the home as an investment property
- Doing a "cash out" refinance with less than 40% equity in the home
- Having a second mortgage to subordinate
The most important thing to remember about LLPAs, though, is that they're not discretionary lender fees; sources of profit or padding by the loan officer or the bank. They are specific fees assigned to specific loan characteristics.
Fannie and Freddie insure against losses in the country's conforming mortgage portfolio and Loan-Level Pricing Adjustments are the fees they charge to insure against extra risk.
The Fannie Mae Loan-Level Pricing Adjustment chart is as thorough as it is punitive.
As a borrower, you can choose to pay your LLPAs as a one-time, at-closing fee. For most people, this is the more economical solution but it does requires an up-front cash payment and not everyone is comfortable doing that. The more common alternative is for people to build the LLPA into their interest rate.
In general, each quarter-percent LLPA loan fee can be offset via an increase of 0.125% on the offered interest rate. In the near-term, this is often the cheapest option but, over the life of the loan, an extra 0.125% can really add up.
It's especially true for real estate investors whose LLPA factors can range as high as 3.000 percent. Higher interest rates eat up the cash flow it takes to make a rental property work -- paying the fees at closing is often the best course.
It doesn't take much to trigger the risk-based pricing matrices of Fannie Mae and Freddie Mac; a lot of conforming mortgage applicants do. If you've read the Fannie Mae LLPA chart and don't know what to make of it, send me an email and I can help you figure it out. The math is simple once you know what you're looking for.
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