Today's mortgage pricing reflects the overall risk of the loan and can increase or decrease the cost of financing to borrowers. Mortgage applicants should look at these price adjustments and know what to expect before shopping for a loan. Fannie Mae, the largest purchaser of mortgage loans from front-line lenders, has devised a "loan level pricing adjustment" structure based on the risk associated with factors such as property type and location, loan amount, down payment or amount of equity, and the borrower's credit score.

Fannie's Formula

Here is an example of how loan level pricing can impact homebuyers and those refinancing their mortgages. In order to calculate the fee, you'll need to know your credit score and understand your loan-to-value ratio (LTV). LTV is the original amount of a mortgage divided by your home's appraised value. Here is an example of how the formula is calculated based on a fictional scenario.

 Loan Level Pricing Fee = loan amount * (loan adjustment fee percentage) / 100

Borrower A has a credit score of 640 and needs a $160,000 mortgage to purchase a $200,000 home. The LTV ratio on this transaction is 80%.  Based on borrower A's credit score and LTV ratio the Fannie Mae loan level adjustment fee is 1.750% of the loan amount::

$160,000 multiplied by 1.750% divided by 100 = $2800

If borrower A's credit score is 720 or better, the loan adjustment fee for the same loan amount and LTV is $0.00 as there is no loan level pricing adjustment for an 80% LTV loan when borrowers have a credit rating of 720 or better.

The Risky Business of Lending

In addition to loan level pricing, Fannie Mae charges a universal fee of .25% for all loans it purchases. Other adjustments include:

• Mortgages on all two-to-four unit properties: add .5% to 1%
• Investment property and mobile homes: add up to 1.5%
• Loans over $417,000: add .25% to .75%

 Good News for Good Credit

It's not all gloom and doom. Those with excellent credit can qualify for a .25% reduction in fees with a substantial down payment. Also, borrowers can choose how they pay the fees -- they can take the form of a lump sum or may be added to the mortgage interest rate -- typically a rate increase of  1/8^th to 1/4th percent will offset 1% in fees. This reduces out-of-pocket costs at closing but increases monthly mortgage payments. 

The advent of loan level pricing adjustments clearly suggests that borrowers' individual credit scores will play a larger role as Fannie Mae adjusts its pricing to reflect risks associated with low credit scores, high LTVs, jumbo loan amounts, soft real estate markets, and riskier property types. Homebuyers with compromised credit or little funding for a down payment will face increased costs as the mortgage lending industry works to reduce future losses. 

Sources:

The Mortgage Report: Fannie Mae;s LLPA Chart

Fannie Mae