Risk-based pricing is a methodology adopted by many lenders in the mortgage A mortgage loan is a loan secured by real property through the use of a document which evidences the existence of the loan and the encumbrance of that realty through the granting of a mortgage which secures the loan. However, the word mortgage alone, in everyday usage, is most often used to mean mortgage loan and financial services Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are banks, credit card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and some government sponsored industries. It has been in use for many years as lenders try to measure loan risk in terms of interest rates and other fees. The interest rate on a loan is determined not only by the time value of money The time value of money is the value of money figuring in a given amount of interest for a given amount of time. For example 100 dollars of today's money held for a year at 5 percent interest is worth 105 dollars, therefore 100 dollars paid now or 105 dollars paid exactly one year from now is the same amount of payment of money with that given, but also by the lender's estimate of the probability that the borrower will default on the loan[1]. A borrower who the lender thinks is less likely to default will be offered a better (lower) interest rate. This means that different borrowers will pay different rates.
The lender may consider a variety of factors in assessing the probability of default. These factors might be characteristics of the individual borrower, like the borrower's credit score A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information, typically sourced from credit bureaus or employment status. These factors might also be characteristics of the loan; for example, a mortgage lender might offer different rates to the same borrower, depending on whether that borrower wished to buy a single-family house A house is generally a shelter or building or structure that is a dwelling or place for habitation by human beings. The term includes many kinds of dwellings ranging from rudimentary huts of nomadic tribes to high-rise apartment buildings. In some contexts, "house" may mean the same as dwelling, residence, home, abode, lodging, or a condominium A condominium, or condo, is the form of housing tenure and other real property where a specified part of a piece of real estate is individually owned while use of and access to common facilities in the piece such as hallways, heating system, elevators, exterior areas is executed under legal rights associated with the individual ownership and.
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Risk factors
Credit score A credit score is a numerical expression based on a statistical analysis of a person's credit files, to represent the creditworthiness of that person. A credit score is primarily based on credit report information, typically sourced from credit bureaus and history, property use A second home is viewed and priced according to lender, some will asses the same risk factor as a primary residence while others will factor in a 0.125% to 0.5% pricing increase to mitigate the perceived risk. Lenders perceive that the borrower is less likely to value the second home if the borrower was faced with financial difficulties, property type, loan amount, loan purpose Pertaining to mortgages and their risk based pricing factors, the loan purpose factor is sub-categorized by purchase, Rate & term refinance and cash-out refinance, income, and asset amounts, as well as documentation levels, property location, and others, are common risk based factors currently used. Lenders 'price' loans according to these individual factors and their multiple derivatives. Each derivative either positively or negatively affects the cost of an interest rate. For example, lower credit scores equal higher interest rates and vice-versa; typically, those who provide less verifiable income documentation due to self-employment benefits will qualify for a higher interest rate than a someone who fully documents all reported income. Mortgage and other financial service Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are banks, credit card companies, insurance companies, consumer finance companies, stock brokerages, investment funds and some government sponsored industries value credit score and history most when pricing mortgage interest rates.
Property types
Pertaining to residential mortgages and their risk based pricing methods, the Property Type is sub-categorized as follows:
- Single Family Residence (SFR)
- Multi-Family 2-4 Units (MF)
- Townhome/Condominium (TC)
SFRs are considered to have the highest dollar value per square foot and are thus the most favorably priced of the property types in the eyes of the lending institution. The property is stand alone, or 'detached' from other property.
Multi-family and townhome/condominiums are typically 'negatively priced', where the lender will assess a .5% to .75% increase in the actual interest rate or the price of an interest rate, due to their relative lower dollar per square foot values.
Criticism
The main criticism among mainstream consumers has been that risk-based pricing can make 'shopping' for the best interest rates much more difficult. It is almost impossible to tell at first glance if one can be qualified to get an advertised rate or exactly what interest rate they qualify for at all. Consumer-rights advocates also believe that risk-based pricing in the extreme, especially in the form of predatory lending Predatory lending is a pejorative term used to describe unfair, deceptive, or fraudulent practices of some lenders during the loan origination process. While there are no legal definitions in the United States for predatory lending, an audit report on predatory lending from the office of inspector general of the FDIC broadly defines predatory, hurts financially disadvantaged and vulnerable consumers by cutting them off from reasonably affordable capital and exposing them unwittingly to soaring interest rates and unsustainable financing schemes that erode equity and may lead to default. Risk-based pricing can be manipulated to wield deceptive marketing practices, such as the bait and switch In retail sales, a bait and switch is a form of fraud in which the party putting forth the fraud lures in customers by advertising a product or service at an unprofitably low price, then reveals to potential customers that the advertised good is not available but that a substitute is. This term has lots of other meanings, even outside of the. The fairness of similar lending practices within the mortgage industry is being investigated by Congress.
References
PR Newswire (press release)
(2) Total risk-based capital ratios are for People's United Bank and, as such, do not reflect the additional capital residing at People's United Financial, ...
Alliance Financial Announces Second Quarter Earnings Centre Daily Times
Riverview Bancorp Reports Positive Earnings in First Fiscal ... FOXBusiness
Alliance Financial Announces Second Quarter Earnings PR Newswire (press release)
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Risk based pricing can bring your bank a significant competitive advantage A growing number of institutions are working with ERisk to introduce state of the art risk based pricing
