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October 19, 2002
"I recently found
what appeared to be the best deal on a 30-year fixed-rate mortgage from
ads in the newspaper, but when I told the loan officer exactly what I
needed, the price rose and the amount I could borrow fell. I figured he
was pulling a bait-and-switch on me, and broke it off. Then I found an
equally good quote by a mortgage broker on the internet, but when I
contacted him the exact same thing happened�What's going on? I need the
loan to buy a condominium to rent out."
You're befuddled by a unique
feature of the US mortgage system that complicates life for mortgage
shoppers. I call it "market nichification". It simply means that
lenders vary the terms they offer borrowers based on a large number of
loan, borrower and property characteristics that they believe affect the
risk or cost of the loan to them.
Your case is an example. Lenders
consider loans that are used to purchase a property for investment riskier
than loans used to purchase a property that will be occupied as a
residence by the borrower. To compensate lenders for the risk, these loans
carry a rate about 3/8% higher than that on loans for personal occupancy.
In addition, the maximum amount you can borrow on an investor loan is
about 70% of property value as opposed to 95% on most loans for occupancy.
While the precise figures will vary a bit from lender to lender, you will
find yourself paying more and able to borrow less no matter which lender
or mortgage broker you solicit.
Here are some other factors that
could have the same effect. A more complete list is shown further below:
- The borrower does not have
permanent residency in the US.
- There is a co-borrower who
won't live in the house.
- There will be a second
mortgage on the house.
- The house is a condominium
with more than 4 stories.
- The borrower wants to avoid
tax and insurance escrow payments.
The number of niches is
enormous because of all the different combinations of the features that
define niches, such as those listed above. Software developed by GHR
Systems, Inc., which many major lenders use to make pricing adjustments,
allows lenders to enter up to 40 million prices for each loan program.
A second loan program could have a different 40 million. While no one
lender uses any significant part of this capacity, in combination the
lenders using the system price for several million niches at least.
Someday when I have nothing better to do I may count them.
Shoppers need to understand
that no lender operates in every niche, and the narrower the niche, the
fewer the lenders. In a survey of 15 national lenders that I did in
response to the letter cited above, I found that all 15 made investor
loans on 30-year fixed-rate mortgages. However, only 9 of them made
investor loans to borrowers who were doing a cash-out refinance, and only
4 were also willing to waive standard loan documentation requirements. On
adjustable rate mortgages, furthermore, the number fell to 2.
Another thing shoppers need to
understand is that the lender offering the best deal in one niche is very
unlikely to be the one offering the best deal in another niche. In a study
of 13 lenders operating in 19 niches that I did some time ago, I found
that 12 of them offered the best deal in at least one niche. Further, no
one of the lenders offered the best deal in more than 3 of the 19 niches.
Nichification is a major
reason why mortgage brokers have become such a major part of the market in
recent years. Since mortgage brokers deal with multiple lenders, usually
30 or more, they are well positioned (as consumers are not) to identify
the lenders who operate in a particular niche, and select the best of the
available deals.
To shop effectively, consumers
need to locate themselves in the correct market niche beforehand. (This is
what the letter-writer did not do.) Otherwise, the shopper does not know
whether the information collected reflects niche pricing or not. It also
helps to have some idea of how your particular niche is priced. Below is a
list of the major niche factors, and some selected illustrations of niche
pricing.
Niche
Factors
All the factors listed below
are used by at least some lenders in pricing mortgages.:
Transaction Characteristics:
1. Loan Amount
2. Desired Lock Period in
Days
3. Down Payment (As Percent
of Property Value)
4. Term
Property if Not Single-Family
Detached:
5. Two-Family
6. Three-Family
7. Four-Family
8. Co-op (Building Is Owned
by a Cooperative Association in Which Members Own Shares)
9. Condominium (Borrowers
Owns Unit in a Project in Which Some Facilities Are Owned in Common)
10. Condominium More Than
Four Stories High
11. Manufactured (House Was
Not Built on Site)
12. Attached
("Twin", "Triplex", "Row")
13. Planned Unit Development
(House Is Located In a PUD With a Homeowners Association That Charges
Dues)
Loan Purpose if Not to
Purchase for Occupancy as Permanent Home:
14. Purchase Second Home
(Vacation Home)
15. Refinance
16. Cash-Out Refinance (Loan
is Larger Than Old Loan Balance By an Amount Larger Than the Settlement
Costs)
17. Investment (Home is
Being Purchased to Rent Out)
Documentation If Not Standard:
18. Alternative Documentation
(Borrower Wants to Provide Payroll and Bank Statements Rather than Wait
For Verification of Information from Employer and Bank)
19. Documentation for
Self-Employed (Borrower Wants to Use Special Documentation Requirements
Available for the Self-Employed)
20. No Income Verification
(Borrower Doesn't Want Reported Income to Be Verified by the Lender)
21. No Asset Verification
(Borrower Doesn't Want Reported Assets to Be Verified by the Lender)
22. "No Docs"
(Borrower Doesn't Want Reported Income or Assets to Be Verified by the
Lender)
23. No Income Ratios
(Borrower Doesn't Want Income to Be Used in Determining Qualifications)
24. Streamlined Refinance
(Borrower Wants the Reduced Documentation Requirements Available on
Refinances Only)
Special Borrower
Characteristics
25. Non-Occupant Co-Borrower
(One of the Borrowers Won't Be Living in the House)
26. Subordinate Financing
(There Will Be a Second Mortgage On the Property When the New Loan is
Made)
27. Non-Permanent Resident
Alien (Borrower is Employed in the US But Is Not a US Citizen or
Permanent Resident )
28. Non-Permenent
Non-Resident Alien (Borrower is Not a US Citizen and is Not Employed in
the US)
29. Waiver of Escrows
(Borrower Wants to Be Responsible For Payment of Taxes and Insurance)
Some Examples
of Niche Pricing on a 30-Year Fixed-Rate Mortgage
Any of the factors listed
above, alone or in combination with others, may affect the interest rate,
points, maximum ratio of loan amount to property value, and sometimes
other qualification requirements. Below are a few common examples, but the
actual numbers shown may vary from lender to lender. All the adjustments
shown are relative to the following "reference" loan:
- Loan Amount: $200,000
- Rate Lock Period: 30 days
- Purpose of Loan: Purchase
for occupancy as permanent home
- Type of Property:
Single-family detached
- Maximum Ratio of Loan to
Property Value (LTV): 95%.
| |
Adjustments
to:
|
|
Niche
Feature
|
Interest
Rate
|
Points
|
Maximum
LTV
|
| Loan
Amount |
|
|
|
|
$45,000
|
+.125%
|
|
|
|
$280,000
|
+.25%
|
|
|
|
$500,000
|
+.25%
|
|
80%
|
|
$800,000
|
+.50%
|
|
70%
|
| |
|
|
|
| Lock
Period |
|
|
|
|
60 days
|
|
+.125
Points
|
|
|
90 days
|
|
+.375
Points
|
|
|
120
days
|
|
+.750
Points
|
|
| |
|
|
|
| Purpose
of Loan |
|
|
|
|
Refinance
|
|
|
90%
|
|
2nd
Home Purch
|
|
|
90%
|
|
Refi
Cash-Out
|
|
|
75%
|
|
Investment
|
+.375%
|
|
70%
|
|
Refi
Cash-Out/Investment
|
+.50%
|
|
60%
|
| |
|
|
|
|
Type of
Property
|
|
|
|
|
2-Family
|
|
|
90%
|
|
3/4
family
|
|
|
80%
|
| |
|
|
|
| Other |
|
|
|
|
No
Income Verification
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+.25%
|
|
70%
|
|
Escrows
Waived
|
+.25%
|
|
90%
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January 9, 2002 Postscript
I took a look at this piece
today and was astounded to see that I did not mention one of the most
important niche factors: the borrower's credit score. Lenders always
check the borrower's credit, and usually rely heavily on a single measure
of creditworthiness called the "FICO score".
FICO scores range up to 850,
which is a perfect score. One lender, for example, provides the
lowest prices only to borrowers with scores above 680. Those between
620 and 680 pay a rate .375% higher on a 30-year fixed-rate loan.
Between 600 and 620 they pay .875% more. And between 580 and 600
they pay 1.25% more. There is no uniformity in how these scores are
used, however, and other lenders may use different cutoff points.
Copyright Jack Guttentag
2004
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