How Mortgage Lenders Price Loans -- and Why You Should Care

So you've probably seen the news about those low mortgage interest rates and their impending rise, but you may not realize that if you were to get a mortgage, your interest and fees may actually be different. Let's look at how rates and risk-based pricing can affect the cost of your loan.

When you see ultra-attractive loan offers or hear the media touting the latest development in interest rates, take it with a grain of salt. Lenders price your loan with adjustments based on certain risk factors set by Fannie Mae and Freddie Mac. Always remember to read the fine print.

Here are most common factors that lenders, banks, and brokers use to calculate a rate and fee offer:

  • Your specific middle credit score
  • Loan-to-value (or, the percentage of your down payment)
  • Loan size
  • Loan product
  • Loan term
  • Lock time frame
  • Purpose of the loan (to purchase or refinance)
  • Occupancy
  • Property type

When you go to apply for a mortgage or request a rate quote, the mortgage company's pricing and rate will reflect these nine pricing adjustments.

The more of these factors that come into play, the riskier the loan. And this is what can make the pricing and rate much different from the national average you'll see or hear about in the news.

Let's say the average national 30-year fixed-rate mortgage is 3.91% with 0.6% in discount points. Here's how that could play out in this scenario:

  • Your credit score is 700
  • Your loan-to-value is 80% (so you have 20% equity or down payment)
  • Your loan size is $418,000
  • It's a conforming loan
  • 30-year fixed-rate mortgage
  • You have a 30-day rate lock
  • $40,000 cash-out refinance
  • Single-family home
  • Primary residence

Here are the factors that can affect the cost of your mortgage:

It would not be uncommon to see a scenario like this resulting in a rate of 4.125% with 0.5% in discount points, for example.

When reviewing your mortgage rates, it's ideal to check them against the national average rather than comparing countless lenders. This is because the national average rate from Freddie Mac already takes into consideration the overall aggregated mortgage market in terms of rates and points anyway.

How mortgage pricing moves with economic news

Here's a quick lesson in finance. Mortgage bond prices move in the form of basis points, and 100 basis points equals 1%.

Certain economic factors change the direction of stocks and bonds, things like domestic and worldly happenings and more specific indicators such as the jobs report, retail sales data, consumer confidence, Federal Reserve meetings, and more.

On any given day the market is negative, unchanged, or improved in the form of basis points. If you have your eyes on a 4% mortgage rate with no points on a 30-year fixed after the lender takes into consideration all of the pricing adjustments, and you're hoping for something better by floating your interest rate (that is, not locking in your rate), and the market worsens 25 basis points, your 4% rate would still be available, but it would come at a cost of 25 basis points of your loan amount. If you're looking at a loan of $400,000, that's $1,000 in the form of discount points based solely on market forces. Such a change would come as a closing item in the form of discount points.

If the market improves by 0.25% and you're looking at that 4% interest rate, now the 25 basis points will be a credit toward fees.

The higher the rate you choose to pay, the lower the fee tied to that specific rate. Conversely, the lower the rate you select, called "no points," where no lender credit is awarded, but there are also no points paid either, is a middle-of-the-road option many opt for.

Market timing is hindsight

There's no such thing as a nonprofit mortgage lender. All mortgage companies -- brokers, banks, credit unions, any financial entity that offers mortgage loans -- have a profit motive.

Securing the lowest possible interest rate is impossible, because you'll never be able to borrow money at the lender's cost of funds, ever. Moreover, there is no way to time the market; all you and your lender can do is make an educated decision about the rate and the pricing tied to your mortgage transaction in lockstep with the market.

Generally, offers from mortgage companies tend to be priced in close proximity to one another on any given day, as lenders have to stay competitive to be profitable. You can expect differences of 0.125% to 0.25% in rate among loan providers. It is up to you, as an informed consumer, to choose the mortgage company you believe will give you a competitive rate and pricing for your specific scenario.

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This article was written by Scott Sheldon and originally published on

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