Last month, we examined some of the factors (most of which are out of our control) that have an effect on your mortgage interest rate. This month, let’s dive a little deeper into the elements that you can control that can also affect your interest rate.
Your credit scores influence a variety of aspects of your life. Of course, loan interest rates are one, but your credit score can also impact your utility bills, insurance pricing and more. When a lender reviews your credit report, they look at multiple pieces of information such as payment history, number of inquiries, amount of debts, lines of credit, and others. When we look at a credit score, we are evaluating what is officially known as a FICO (for Fair Isaac Corporation) score. FICO is an analytics software company that provides services to businesses and consumers but they are best known for providing the credit scores that are used to influence credit decisions.
A credit report generally lists the score provided by each of three nationwide credit reporting agencies: TransUnion, Equifax, and Experian. Each agency collects information and while there is a lot of similarity in the information, scores between the agencies can vary for many reasons. For example, lenders don’t always report debts to all three agencies. Because of this, the data in your reports can vary, making each agency’s score different. Because of the varying scores, as the basis of the credit decision, lenders generally use the borrower’s middle score (or if there are two/joint borrowers they will use the lower of the two middle scores). You may have a credit card or bank account that provides your credit score as a free benefit. These are not your official FICO scores and lenders have to base their decisions using the scores shown on your official credit report.
Once a lender has evaluated your credit, everything is put into a Loan Origination Software (LOS) program. Daily, and sometimes more-often, lenders publish a rate sheet. Rate sheets list the pricing for interest rates based on several factors. Each loan program and specific interest rate has a base price that is valid for a specific period of time (from just a few days to as long as 60 or even 90 days). When you “lock” your rate, you are locking in this pricing. The lender then applies “loan-level pricing adjustments” to that base price. Here are some examples of the loan-level price adjustments that a lender may apply:
• Loan-to-value – the ratio of the loan amount to the appraised value or purchase price, whichever is lower
• Loan amount
• Credit Score – the lender will have different pricing tiers for various credit scores; better scores equal better pricing
• Loan-type – e.g., a cash-out refinance may have a price adjustment that a rate and term refinance do not have
• Secondary financing – if a borrower has a second mortgage, home equity line of credit or other type of loan secured by the property, the lender will often apply a price adjustment
After applying the adjustments to the base price, a lender arrives at a final price for the interest rate. That price may offer what’s known as a “lender credit” or it may have what’s known as “discount points.” Here’s an example of the pricing for a 2.75% rate for a $336,400 loan on a property appraised at $490,000 with a credit score of 732. Adjustment percentages are based on a percentage of the loan amount:
|Adjustment Name||Adjustment %||Dollar Amount|
|Base Price||-2.315||($7,787.66)||The base price offers a CREDIT of this amount|
|FICO 720-739 LTV 60.01%-70%||.250||$841||There is an $840 penalty for the credit score and LTV (loan to value ratio) combination. A higher score or lower LTV may reduce or eliminate this penalty. A lower score or higher LTV may incur an additional penalty.|
|Refinance Loan >$125,000||.500||$1,682||For most refinance loans delivered to Fannie Mae/Freddie Mac, there is a .5% “Adverse Price Adjustment” charged|
|Final Price||-1.565||(-$5,264.66)||This is the final amount of credit (in this case) for the particular interest rate)|