In my last post, I responded to a question that Wicker Park Realtor  Dave Weiss asked about why advertised rates are never right. Part of the reason is because so many lenders play fast and loose with the truth in order to get their phones to ring. This is a classic bait and switch, and it gives our industry a bad reputation.

Another part of the picture is that there is no way that an advertised rate can be correct without taking into account all the factors which go into pricing a loan. When a lender takes on a new mortgage their goal is to minimize their risk and make sure that they are getting paid for the risks they are accepting. Lenders access their risk first by underwriting the loan and making sure it meets all their guidelines. Based on past performance, some loan characteristics increase the chance that the borrower will default on their loan, costing the lender money. Lenders, mortgage bankers, and mortgage brokers are willing to approve loans which have these factors, but they want either a higher rate or more fees in order to make up for the higher risk.

Here are some of the things that factor into the price of a loan, and how I price out my Illinois Mortgage Rates:

Credit scores – Fico scores are a measure of how likely a borrower is to pay back the loan. Up until recently, if you qualified for a conventional loan (a loan that was eligible for purchase by Fannie Mae or Freddie Mac, the 2 biggest purchasers of mortgages in the aftermarket) your pricing would be the same whether your score was in the low 600s or the high 800s. If you didn’t meet these guidelines you could still get a mortgage at a higher rate, but these were considered Alt-A or sub prime loans. But that is changing because of all the problems in the mortgage market. Sub prime and Alt-A loans are pretty much gone now, and Fannie Mae and Freddie Mac have recently adopted risk based pricing. This means that Borrowers with lower down payments and credit scores below 680 will now pay more for their mortgages.

In order to quote an accurate mortgage interest rate, you need to know the Fico score first. This makes it all the more crucial to review your credit and work on any problems before you are ready to apply for a loan.

Loan type – Even when comparing 30 year fixed rate loans, there are a whole variety of programs available, each to meet specific needs. The pricing changes based on the loan type. Conventional loans (Fannie and Freddie) are good up to $417,000 for a single family home. If your loan is above that you would most likely look at a Jumbo loan. Jumbo mortgages are not able to be sold to Fannie Mae and Freddie Mac, so they are priced higher.

If you qualify best for an FHA loan, the pricing would be different. The same goes with many of the first time home buyer loans like My Community, the Community Home Buyer Loan and the City of Chicago Bond program, or other bond loans.

LTV and CLTV – This means the Loan to Value and the Combined Loan to Value, or how much is the mortgage compared to the value of your home, and how much if you include any other mortgages on that home. This is another way of stating how much equity you have in your home - the higher the equity, the lower the loan to value. And the less equity you have, the higher the risk is to the lender. Part of this risk is taken up by having mortgage insurance for loans with less than 20% equity, in some cases it is taken up by higher pricing.

Are you buying with a second mortgage added on? In the past this has been a great way to buy with less money down and avoid mortgage insurance. It is harder to do in many cases now, and you may pay more on your first mortgage if you have a second loan attached.

Loan purpose – Are you buying a home or refinancing? If you are refinancing your home and taking cash out, it would cost you more if your loan to value is greater than 70% (less than 30% equity).

Occupancy – Is this your primary residence, a second home or an investment property? You get the best rates and fees for your primary residence. Second home loans are often the same, but in some cases they can be slightly higher. Investment property is looked at as a riskier type of loan and investors are more likely to walk away from a bad investment, than home owners are on their homes. So there are higher rates and fees when you buy non-owner occupied or investment homes.

Type of property – Mortgages for single family and two unit homes are priced better than loans for three or four unit homes. Buying a condo may also mean you pay a little more, depending on the loan program and your loan to value. Especially if it is a new construction condo or a condo converted from rental units.

Loan amount – On conventional loans, pricing is usually better for larger loans. It costs the same to process and close a small loan as it does for a larger mortgage. Because of this the pricing improves on loans over $200,000. On the other side, loans under $100,000 have increased fees, and the fees go higher as the loan price drops.

Documentation type – Pricing is better for loans where you show documentation to prove your income and assets than if you took on a loan with less documentation. These loans aren’t as big of a factor in the market as they were a year or so ago.

Property location – There are some areas in the city of Chicago and in the Chicago suburbs that are considered target areas. These neighborhoods are targeted for redevelopment and banks are encouraged to lend in these areas – more than encouraged, they have to have to lend a certain amount in low income areas or they could face big problems with the federal government. Because of this pricing in these areas is better. The original idea here was to offer more homes for low and moderate income borrowers. Often the areas marked for redevelopment are the hot areas where prices are rising. Make sure your loan officer checks to see if you are in a CRA or targeted area.

Buying out of state the pricing can be different, too. I specialize Illinois Mortgages, but also close loans in most states. The wholesale lenders have different rates for each state.

Length of the rate lock – You will get slightly better pricing for a 15 day rate lock than if you locked your rate in for 60 days.

Escrows – Mortgages are usually priced so that the end lender will hold your escrows for taxes and insurance, collect 1/12^th of the payment from you every month and pay the bills when they come due. Many borrowers want to pay these bills themselves and earn the interest on their money until the bills come due. You can do this if you meet certain guidelines, but it will cost you. Most lenders charge a quarter point fee if you waive your escrows. On a $300,000 loan this is an extra cost of $750.

Pre-payment penalty – If you know you aren’t going to be moving or refinancing for a while, you can sometimes get a lower rate by agreeing to pay a pre-payment penalty. This will lower your costs, but it also handcuffs you into staying in the mortgage. If you end up moving or refinancing before the time expires, it could cost you a lot.

These are some of the things that factor into the rate and cost of a mortgage. Even bigger though is how the loan fits your needs and what you qualify for best. It doesn’t make any sense to shop the rate on a conventional mortgage if you can only qualify for FHA. Also, make sure you look at the bigger picture, not only the interest rate but the costs of the loan and how the financing works for your personal situation.

I’ll have more on what you can do to make sure you get the best rates and fees when shopping for a loan in upcoming posts.

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