Risk-Based Mortgage Pricing
What Is Risk-Based Mortgage Pricing?
Risk-based mortgage pricing is a practice where lenders present loan terms and conditions to individual applicants based on the lender's assessment of the borrower's level of risk in regards to stretching out credit to that particular borrower.
Understanding Risk-Based Mortgage Pricing
Mortgage lenders offer varying interest rates and loan terms to various borrowers based on a grading of the creditworthiness of each borrower. Lenders grade borrowers and offer various rates and terms to them, based on several criteria, including the borrower's credit score, payment history, and the loan to value ratio of the mortgage. Risk-based pricing is commonly utilized by Alt-A and subprime lenders.
Risk-based mortgage pricing is similar to practices utilized by creditors of different types of loans, for example, credit card companies and car loan financing lenders. These lenders will typically offer better deals and terms to applicants with better financial circumstances and credit histories. While making decisions including the approval of loan or credit demands, these lenders gauge the risk that the borrower is probably going to default or become delinquent on the loan, and then package their offers accordingly.
Borrowers who have had a bankruptcy or foreclosure, who have recently been jobless, or who have had recent late payments or other credit issues will probably be offered a less attractive interest rate than borrowers with a more positive credit record.
This is standard practice, is totally legal, and is common in the financial industry. Nonetheless, lenders cannot utilize legally denied factors in deciding terms or making approval decisions for mortgage or credit applications. These precluded factors incorporate orientation, marital status, race, and religion.
On the off chance that a borrower is offered less attractive terms or rates based even in part on something found in their credit report, they will usually receive a notice illuminating them regarding the specific factors from their credit report that played a job in this decision.
Benefits of Risk-Based Mortgage Pricing
Risk-based mortgage pricing greatly benefits the lender because it safeguards them against default. The higher interest rate charged to borrowers with lower credit quality makes up for the increased risk of lending them money. The practice also benefits borrowers with a decent credit history because it allows them to obtain mortgages at low prices.
Risk-based mortgage pricing also assists individuals with a poor credit history to have the option to buy a house where they may somehow or another not have had the option to do so based on their poor credit score or other restricting factors. Because a high-risk borrower can be charged an interest rate above the standard rate, a bank will be more comfortable lending them money to buy a house.
This would then work on the financial condition of the borrower as they will have equity in a home, and on the off chance that they are able to outfit their mortgage payments without issue, it will eventually further develop their credit history.
Of course, this can backfire as well, as it did in the subprime meltdown that prompted the 2008 financial crisis. Subprime borrowers who had very poor credit were given mortgages, which sooner or later they couldn't make payments on and defaulted.
Risk-Based Mortgage Pricing Expanding Credit Options
Risk-based mortgage pricing has expanded the types of mortgages lenders can offer and has increased the number of borrowers that can generally qualify for a mortgage.
Alt-An and subprime mortgages, the types of mortgages generally subject to risk-based pricing, are regularly sold by the mortgage originator into the secondary mortgage market, where they typically become part of collateralized mortgage obligations (CMOs), asset-backed securities (ABSs), and collateralized debt obligations (CDOs).
Risk-based pricing plays a large part in the organizing of CMOs, ABSs, and CDOs, enhancing their overall credit rating and making them attractive to a great many investors.
Features
- Borrowers with a strong credit profile will be offered better terms, for example, lower interest rates, whereas borrowers with a poor credit profile will be offered harsher terms, for example, higher interest rates.
- Risk-based mortgage pricing benefits a lender as it allows them to charge higher rates to subprime borrowers, mitigating risks. It benefits subprime borrowers because they are able to buy a house whereas they may not have the option to under standard loan terms.
- Risk-based mortgage pricing is the practice of lenders offering loan terms and conditions to applicants based exclusively on their credit profile.
- Lenders assess the riskiness of a borrower based on a variety of factors, for example, credit score, and offer loan terms that are tailored specifically to that individual.
