Explaining Loan-Level Pricing Adjustments (Featuring An Online Calculator)
If you've ever wondered why you can't get the best "advertised rate", it's not because of some elaborate bait-and-switch scheme or something worse. Most likely, your rates have been altered by Loan-Level Pricing Adjustments.
Loan-Level Pricing Adjustments Change Every 5 Months
Loan-level pricing adjustments are changes in your loan costs based on your individual risk to a bank. LLPAs were first introduced in April 2008 as a way to help Fannie Mae and Freddie Mac stay solvent. They've been amended a half-dozen times since.
There's new LLPAs to deal with every 5 months or so.
Despite its 3-year history, however, LLPAs remain under-the-radar to most the American people. The first time that people tend to hear of them is at the point of application. Often, as an explanation about why the rate they're getting is a half-point higher than the "market rate".
Loan-level pricing adjustments may seem unfair, but they use a pricing model with which we're intimately familiar.
Using Auto Insurance To Explain LLPAs
In the World of Mortgage, risk-based pricing tends to confuse people and our goal here is to find understanding. So, to get a better handle on the concept, let's look to another industry that relies on risk-based pricing; one with which we're intimately familiar.
Auto insurance. The way that auto insurance companies calculate premiums is remarkably similar to how mortgage lenders calculate LLPAs.
First, there is some base insurance rate for which we all qualify. That rate is based on the ZIP code in which we park and the number of miles we drive.
Then, from that initial price point forward, premiums vary from driver-to-driver based on the driver's individual driving risk. Risk categories include age, driving history, and car type.
More risk means more costs.
Risk Factors That Lead To Loan-Level Pricing Adjustments
Loan-level pricing adjustments work just like auto insurance. With more risk, comes more premium. It's an add-on to the base rates set by Wall Street.
There's a host of LLPA trigger traits. A fair sample set follows:
- Living in a condo with less than 25% equity in the home
- Having a credit score of less than 740
- Living in a 2-unit, 3-unit or 4-unit home
- Using a home as an investment property
- Doing a "cash out" refinance with less than 40% equity in the home
- Having a second mortgage to subordinate
And, and if this list wasn't long or punitive enough, starting April 1, 2011, regardless of credit score, all conforming loans with less than 25% equity will be subject to LLPA.
LLPAs Are Mandatory. Everyone Pays.
LLPAs are not discretionary fees, nor are they a source of profit to a bank. LLPAs are costs tied to specific loan risks. They're charged by Fannie Mae and Freddie Mac and there's no getting around them. If you trigger the chart, you pay the fees. Period.
The good news? You can choose how you pay your LLPA fees:
- LLPAs can be paid as a traditional "closing cost", a one-time payment due at closing.
- LLPAs can be built into your interest rate. In general, increase your interest rate +0.250% for each 1 percent in loan-level pricing adjustment.
This online LLPA calculator will show you what you'll owe.
Need More Info On Loan-Level Pricing Adjustments?
If you've triggered the LLPA chart and want to know your options, ask for help. Depending on your loan traits, there may be non-Fannie /Freddie loans that can give the same great rates, but without the high-risk fees.
In general, 1 in 4 borrowers has an alternative so be sure to ask me about it.