Risk-based pricing
Risk-based pricing is a method the mortgage industry relies on to adjust interest rates based on borrower profile. To mitigate any potential risk, banks and lenders have created pricing adjustments for a variety of loan criteria. In simple terms, a borrower deemed more risky by a bank or lender will receive a higher interest rate. After all, it makes perfect sense to give the more qualified borrower the better rate.
There are a number of factors that can adjust the pricing of your loan. One of the most important factors will always be credit. Credit scores range from 300-850, and greatly affect the rate you will ultimately receive. Scores above 720 are generally the highest tier, and will offer a rebate to the rate you receive. Look at this example:
Fico score >720 score = .375% rebate
Fico score 660-679 = .25% cost
Note that scores between 680 and 720 weren’t used, and aren’t assigned a cost or a rebate. However, scores over 720 received a rebate of .375%, while scores between 660-679 were slapped with a .25% cost. These costs or rebates associated with each rate are known as adjustments to fee. Fee is another name for rebate, or yield spread premium.
So if an interest rate of 6% has a base rebate of .625%, a 721 fico score would raise that base rebate to .875%, and a score between 660-679 would lower that base rebate to .375%. This net rebate is known as the yield spread premium the broker or bank will receive on your loan. And if a bank or broker finds this yield spread premium dwindling because of excessive adjustment costs associated with your loan, they will likely have to raise the rate to take in a higher rebate. So the more costs associated with your loan, the less rebate your broker or bank will be left with, and the higher the rate will be to ensure they get paid to do your loan.
For more information related to risk-based pricing, see my page on mortgage pricing adjustments.
