Risk Based Pricing.  How Mortgage Rates are Determined  Property Location and Property Use

In the world of residential mortgage Risk Based Pricing (RBP), Property Location and Property Use are two factors that have nothing to do with the actual borrower, whereas the same borrower would receive two different sets of program and interest rate quotes depending on where the subject property is located and what the property is used for.

Property Location has become much more prominent in RBP scenarios with the recent uptick in popularity of FHA mortgages.  Loan limits for FHA loans have become very localized, right down to the County level.  It’s possible that one County may have a loan limit of ~$417k with an adjacent County at ~$700k+, via FHA.  Loan amounts above local limits will cause a pricing for the worse, so location in relation to loan amount can be a substantial factor as to what interest rate any given borrower qualifies for.

Even without considering FHA loan limit guidelines, there are state level and regional rate and pricing guidelines…you wont get the same programs, rates and pricing in Kanosh, UT and Manhattan.  Property in locations deemed high risk (depreciating, bubble/volatile prone, high foreclosure, poor economy) are likely to see a pricing for the worse (higher interest rate) compared to ‘more stable’ locations.   There are even locations like the inner city of Cleveland, Ohio where many banks won’t lend, period, due to the depth of mortgage fraud that ripped through the city during the refi-boom.

Property based RBP changes can range from 0% to 2% (or pts) which may have a corollary  effect of increasing the interest rate 1+%.

Property Use is broken down into three subsets:

• Primary Residence
• Second Home
• Non-Owner Occupied or Investment

A Primary Residence is a property you plan to personally live in.  The bank thinks you’re likely to highly value and treat the house you live in with love and respect so properties that are used for primary residences have no RBP adjustment for the worse.

RBP adjustments for Second Homes are getting pretty lender specific, depending on secondary factors like credit score and Loan to Value (LTV).  Second Homes with LTV’s <80% generally have no RBP adjustment while an LTV >80% will require higher credit scores and RBP for the worse.    In order for a property to qualify as a Second Home, you can’t (claim to) make money by renting it out (this would make it an investment property), and you must represent that you stay at the property a certain amount of time each year.

Non-Owner Occupied or Investment Property will have a substantial RBP adjustment for the worse, typically between 1.5%-2.5% which may correlate to 1%+ increase in interest rate, compared to a primary residence or second home, regardless of  any secondary factors.  Secondary factors like loan amount and LTV play a heavy role in how big the adjustment is.

Where there is up to 2.5% (or points) on the table there are likely to be people trying to game the system.  Misrepresenting property use is a very common type of mortgage fraud since it’s heavily based on the honor system.  Yes, stating that a property you are buying will be your primary residence when you really intend to rent it out is mortgage fraud.  There are certain measures the bank and broker (should) go through to make sure the stated property use is in fact true.

Next up is Credit Scores and History…